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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002

DUSA Pharmaceuticals, Inc.
(Exact Name of Registrant as Specified in Its Charter)

NEW JERSEY 22-3103129
(State or Other Jurisdiction of (I.R.S. Employer)
Incorporation or Organization)

25 Upton Drive 01887
Wilmington, Massachusetts (Zip Code)
(Address of Principal Executive Offices)

Commission File Number: 0-19777
Registrant's telephone number, including area code: (978) 657-7500
Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to section 12(g) of the Act:

Common Stock, no par value
(Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No | |

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 or Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes | | No |X|

The aggregate market value of the voting and non-voting common equity
stock held by non-affiliates computed by reference to the price at which the
common equity was last sold, or the average bid and asked price of such common
equity, as of the last business day of the Registrant's most recently completed
second fiscal quarter was $25,814,033.

The number of shares of common stock outstanding of the Registrant as of
March 5, 2003 was 13,887,612.

DOCUMENTS INCORPORATED BY REFERENCE

Document incorporated by reference to this Report is:

(1) Proxy Statement for the 2003 Annual Meeting of Shareholders. Part
III, Items 10 through 13.



PART I

This Annual Report on Form 10-K and certain written and oral statements
incorporated herein by reference of DUSA Pharmaceuticals, Inc. (referred to as
"DUSA," "we," and "us") contain forward-looking statements that have been made
pursuant to the provisions of the Private Securities Litigation Reform Act of
1995. Such forward-looking statements are based on current expectations,
estimates and projections about DUSA's industry, management's beliefs and
certain assumptions made by our management. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates," or variations
of such words and similar expressions, are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and are subject to certain risks, uncertainties and assumptions that
are difficult to predict particularly in the highly regulated pharmaceutical
industry in which we operate. Therefore, actual results may differ materially
from those expressed or forecasted in any such forward-looking statements. Such
risks and uncertainties include those set forth herein under "Risk Factors" on
pages 29 through 43, as well as those noted in the documents incorporated herein
by reference. Unless required by law, we undertake no obligation to update
publicly any forward-looking statements, whether as a result of new information,
future events or otherwise. However, readers should carefully review the
statements set forth in other reports or documents we file from time to time
with the Securities and Exchange Commission, particularly the Quarterly Reports
on Form 10-Q and any Current Reports on Form 8-K.

ITEM 1. BUSINESS

GENERAL

We are a pharmaceutical company developing drugs in combination with light
devices to treat or detect a variety of conditions in processes known as
photodynamic therapy or photodetection. We are engaged primarily in the
research, development and marketing of our first drug, the Levulan(R) brand of
aminolevulinic acid HCl, or ALA, with light, for use, or potential use, in a
broad range of medical conditions. When we use Levulan(R) and follow it with
exposure to light to treat a medical condition, it is known as Levulan(R)
photodynamic therapy, or Levulan(R) PDT. When we use Levulan(R) and follow it
with exposure to light to detect medical conditions it is known as Levulan(R)
photodetection, or Levulan(R) PD.

Our first products, the Levulan(R) Kerastick(R) 20% Topical Solution with
PDT and the BLU-U(R) brand light source were launched in the United States in
September 2000 for the treatment of actinic


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keratoses, or AKs, of the face or scalp. AKs are precancerous skin lesions
caused by chronic sun exposure that can develop over time into a form of skin
cancer called squamous cell carcinoma.

On November 22, 1999, we signed a marketing, development and supply
agreement with Schering AG, a German corporation, for our dermatology products.
We granted to Schering AG the right to promote, market, sell, and distribute our
Levulan(R) Kerastick(R) with PDT for AKs of the face or scalp on a worldwide
basis (with the exception of Canada). In the United States, Schering AG's United
States affiliate, Berlex Laboratories, Inc., marketed these products. Schering
AG also promoted the BLU-U(R); however, we were responsible for distributing the
BLU-U(R) units, as well as for their repair and maintenance. We leased or rented
the BLU-U(R) to physicians, medical institutions and academic centers throughout
the country. We were also co-developing for commercialization with Schering AG
additional Levulan(R) products for other dermatology disorders. Under the
agreement, Schering AG had the exclusive right to market, promote, sell and
distribute the products which were developed in the co-development program. On
September 1, 2002, DUSA and Schering AG terminated the agreement and DUSA
reacquired all rights it had granted to Schering AG. Consequently, DUSA has
commenced marketing its products directly, and is now responsible for all
regulatory, customer service, and other related activities which will result in
significant new expenses, especially if we decide to develop a sales force in
the future.

Also, as a result of the termination of our collaboration, we have
reevaluated our operations and have reduced research and development and related
general and administrative expenditures that are not directly related to our
core objectives for 2003. These objectives include increasing the sales of our
AK products in the United States, conducting clinical trials which, if
successful, could support a broader AK indication, and seeking a partner to help
develop and market Levulan(R) PDT for the treatment of dysplasia in patients
with Barrett's esophagus. In addition, we continue to support independent
investigator trials to advance research in the use and applicability of
Levulan(R) PDT for indications in dermatology, as well as for ablation of
low-grade and high-grade dysplasia in Barrett's esophagus, among others. See
section entitled "Business - Internal Indications."

We are developing Levulan(R) PDT and PD under an exclusive worldwide
license of patents and technology from PARTEQ Research and Development
Innovations, the licensing arm of Queen's University, Kingston, Ontario, Canada.
We also own or license certain other patents relating to methods for using
pharmaceutical formulations which contain our drug and related processes and
improvements. In the United States, Levulan(R), Kerastick(R) and BLU-U(R) are
registered trademarks. These trademarks are also registered in Europe, Canada,
and in other parts of the world. See sections entitled "Business - Licenses; and
- - Patents and Trademarks."


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We were incorporated on February 21, 1991, under the laws of the State of
New Jersey. Our principal executive offices are located at 25 Upton Drive,
Wilmington, Massachusetts 01887 (telephone: (978) 657-7500). On March 3, 1994,
we formed DUSA Pharmaceuticals New York, Inc., a wholly owned subsidiary located
in Valhalla, New York, to coordinate our research and development efforts. We
have financed our operations to date, primarily from sales of securities in
public offerings, private and offshore transactions that are exempt from
registration under the Securities Act of 1933, as amended, (the "Act"), and from
payments received as part of the agreement with Schering AG. See sections
entitled "Management's Discussion and Analysis of Financial Condition -
Overview; - Results of Operations; and - Liquidity and Capital Resources."

BUSINESS STRATEGY

The following are the key elements of our strategy:

- Support the Marketing of our First Products. DUSA is in the process
of implementing a new marketing, education, and development
strategy. The Company is focusing on meeting the needs of
dermatologists, and educating them about the benefits of our
therapy, in an effort to increase product sales over time. Our
activities include the support of medical education, participation
in dermatology conferences, support of Company-sponsored research
and development efforts and independent investigator studies, and
support of efforts to improve third party reimbursement. DUSA has
decided not to create a nationwide sales force, or to seek a new
dermatology marketing partner at this time; however, we do intend to
carry out limited regional test marketing during 2003.

- Leveraging our Levulan(R) PDT/PD Platform to Develop Additional
Products. In the field of dermatology, we are planning clinical
studies related to AKs that, if successful, could lead to enlarged
market opportunities for our approved products. We are also
supporting independent investigator studies that may lead to
additional Levulan(R) products for other skin conditions such as
psoriasis, photorejuvenation, inflammatory acne, warts, molluscum
contagiosum, oily skin, and acne rosacea. Outside of dermatology, we
are developing products that target large markets with unmet medical
needs, such as the treatment of high-grade dysplasia within
Barrett's esophagus dysplasia.

- Enter into Additional Strategic Alliances. If we determine that the
development program for a non-dermatology indication may be beyond
our own resources or may be advanced to market more rapidly by
collaborating with a corporate partner, we may seek opportunities to
license, market or co-promote our products. We are currently seeking
a strategic partner to join in the development, marketing, and
distribution of our treatment for Barrett's esophagus dysplasia. In
addition, we recently completed a license of ALA technology for the
fluorescence-guided


4


resection of brain cancer which provides for potential additional
joint development activities.

- Use the Results of Independent Researchers to Identify New
Applications. We will continue to support independent investigators'
research so that we have the benefit of the resulting 'anecdotal'
human data for use in evaluating potential indications for corporate
development. We will also continue to monitor independent research
in order to identify other potential new indications.

PDT/PD OVERVIEW

In general, both photodynamic therapy and photodetection are two-step
processes:

- The first step is the application of a drug known as a
"photosensitizer," or a pre-cursor of this type of drug, which tends
to collect in specific cells.

- The second step is activation of the photosensitizer by controlled
exposure to a selective light source.

During this process, energy from the light activates the photosensitizer.
In PDT, the activated photosensitizer transfers energy to oxygen molecules found
in cells, converting the oxygen into a highly energized form known as "singlet
oxygen," which destroys or alters the sensitized cells. In PD, the activated
photosensitizer emits energy in the form of light, making the sensitized cells
fluoresce, or "glow."

The longer the wavelength of visible light, the deeper into tissue it
penetrates. Different wavelengths, or colors of light, including red and blue
light, may be used to activate photosensitizers. The selection of the
appropriate color of light for a given indication is primarily based on two
criteria:

- the desired depth of penetration of the light into the target
tissue, and

- the efficiency of the light in activating the photosensitizer.

Blue light does not penetrate deeply into tissues, and is better suited
for treating superficial lesions. It is also generally a potent activator of
photosensitizers. Red light penetrates more deeply into tissues, and is better
suited for treating cancers and deeper tissues. However, it is generally not as
strong an activator of photosensitizers. Different photosensitizers do not
absorb all colors of visible light in the same manner. For any given
photosensitizer, some colors are more strongly absorbed than others.


5


Another consideration in selecting a light source is the location of the
target tissue. Lesions on the skin which are easily accessible can generally be
treated with a non-laser light source. Internal indications, which are often
more difficult to access, may require a laser in order to focus the light into a
small fiber optic delivery system that can be passed through an endoscope or
into a hollow organ.

PDT can be a highly selective treatment that targets specific tissue while
minimizing damage to normal surrounding tissue. It also can allow for multiple
courses of therapy. The most common side effect of photosensitizers that are
taken systemically is temporary skin sensitivity to bright light. Patients
undergoing PDT and PD treatments are usually advised to avoid direct sunlight
and/or to wear protective clothing during this period. Patients' indoor
activities are unrestricted except that they are told to avoid bright lights.
The degree of selectivity and period of skin photosensitivity varies among
different photosensitizers and is also related to the drug dose given.
Generally, photosensitizers or light used separately have no PDT/PD effects.

OUR LEVULAN(R) PDT/PD PLATFORM

OUR LEVULAN(R) BRAND OF ALA

We have a unique approach to PDT and PD, using the human cell's own
natural processes. Levulan(R) PDT takes advantage of the fact that ALA is the
first product in a natural biosynthetic pathway present in virtually all living
human cells. In normal cells, the production of ALA is tightly regulated through
a feedback inhibition process. In our PDT/PD system, excess ALA (as Levulan(R))
is added from outside the cell, bypassing this normal feedback inhibition. The
ALA is then converted through a number of steps into a potent natural
photosensitizer named protoporphyrin IX, or PpIX. This is the compound that is
activated by light during Levulan(R) PDT/PD, especially in fast growing cells.
Any PpIX that remains after treatment is eliminated naturally by the same
biosynthetic pathway.

We believe that Levulan(R) is unique among PDT/PD agents. It has the
following features:

- Naturally Occurring. ALA is a naturally occurring substance found in
virtually all living human cells.

- Small Molecule. Levulan(R) is a small molecule that is easily
absorbed whether delivered topically, orally, or intravenously.

- Highly Selective. Levulan(R) is not itself a photosensitizer, but is
a pro-drug that is converted through a cell-based process into the
photosensitizer PpIX. The


6


combination of topical application, tissue specific uptake,
conversion into PpIX and targeted light delivery make this a highly
selective process. Therefore, under appropriate conditions, we can
achieve selective clinical effects in targeted tissues with minimal
effects to normal surrounding and underlying tissues.

- Controlled Activation. Levulan(R) has no PDT effect without exposure
to light at specific wavelengths, so the therapy is easily
controlled.

Scientists believe that the accumulation of PpIX following the application of
Levulan(R) is more pronounced in:

- rapidly growing diseased tissues, such as precancerous and cancerous
lesions,

- conditions characterized by rapidly proliferating cells such as
those found in psoriasis, and certain microbes and

- in certain normally fast-growing tissues, such as hair follicles,
sebaceous glands, esophageal mucosa and the lining of the uterus.

OUR KERASTICK(R) BRAND APPLICATOR

We designed our proprietary Kerastick(R) specifically for use with
Levulan(R). It is a single-use, disposable applicator, which allows for the
rapid preparation and uniform application of Levulan(R) topical solution in
standardized doses. The Kerastick(R) has two separate glass ampoules, one
containing Levulan(R) powder and one containing a liquid vehicle, both enclosed
within a single plastic tube and an outer cardboard sleeve. There is a filter
and a metered dosing tip at one end. Prior to application, the doctor or nurse
crushes the ampoules and shakes the Kerastick(R) according to directions to mix
the contents into a solution. The Kerastick(R) tip is then dabbed on to the
individual AK lesions, releasing a predetermined amount of Levulan(R) 20%
topical solution.

OUR LIGHT SOURCES

Customized light sources are critical to successful Levulan(R) PDT/PD
because the effectiveness of Levulan(R) therapy depends on delivering light at
an appropriate wavelength and intensity. We intend to continue to develop
integrated drug and light device systems, in which the light sources:

- are compact and tailored to fit specific medical needs,

- are pre-programmed and easy to use, and

- provide cost-effective therapy.


7


Our proprietary BLU-U(R) is a fluorescent light source that can treat the
entire face or scalp at one time, which has been specifically designed for use
with Levulan(R). The light source is reasonably compact and portable. It can be
used in a physician's office, requires only a moderate amount of floor space,
and plugs into a standard electrical outlet. The BLU-U(R) also incorporates a
proprietary regulator that controls the optical power of the light source to
within specified limits. It has a simple control panel consisting of an on-off
key switch and digital timer which turns off the light automatically at the end
of the treatment. The BLU-U(R) is also compliant with CE marking and ISO 9001
requirements.

We are using non-laser light sources whenever feasible because, compared
to lasers, they are:

- safer,

- simpler to use,

- more reliable, and

- far less expensive.

For treatment of AKs, our BLU-U(R) uses blue light which penetrates
superficial skin lesions and is a potent activator of PpIX. Longer red
wavelengths penetrate more deeply into tissue but are not as potent activators
of PpIX. Therefore, for treatment of superficial lesions of the skin, such as
AKs, we are using relatively low intensity, non-laser blue light sources, which
are designed to treat large areas, such as the entire face or body. For
treatment of diseases that may extend several millimeters into the skin or other
tissue, for example, most forms of cancer, high-powered red light is often
preferable. We have United States and foreign patents and patent applications
pending which relate to devices and methods of using light devices for use in
Levulan(R) PDT and PD. See section entitled "Business - Patents and Trademarks."

Our Levulan(R) PDT/PD research and development team has experience in the
development and regulatory approval process of both drugs and devices for use in
clinical PDT/PD.


8


OUR PRODUCTS

The following table outlines our products and product candidates. Our
research and development expenses for the last three years were $12,121,606 in
2002, $10,789,906 in 2001, and $8,163,419 in 2000.



INDICATION/PRODUCT STATUS OF REGULATORY STUDIES
------------------ ----------------------------

DERMATOLOGY

Levulan(R) Kerastick(R) and BLU-U(R) for PDT of AKs Approved; Phase IV

Levulan(R) PDT for Onychomycosis (Nail Fungus) Phase I/II(1)

Levulan(R) PDT for Persistent Foot Wart Removal Phase I/II(1)

Levulan(R) PDT for Acne Phase I/II(1)

Levulan(R) PDT for Broad Area AKs Phase III(2)

OTHER INDICATIONS

Levulan(R) PDT for Barrett's Esophagus Dysplasia Phase I/II

Levulan(R) induced fluorescence guided resection for brain cancer European Phase III(3)(4)


(1) Further Phase II development for the onychomycosis, warts, and acne
indications is not planned at this time.

(2) Phase III study to be proposed to FDA in early 2003.

(3) Licensed from Photonamic GmbH & Co. KG.

(4) European Phase III trial results may not be acceptable to the FDA in the
United States.

DERMATOLOGY INDICATIONS

As of January 1, 2003, DUSA assumed all responsibility for its dermatology
research and development program. In the prior 2 years, our former dermatology
marketing partner had contributed nearly $3 million per year to the program.
With our decision to focus on clinical trials which, if successful, could
support a broader AK indication, together with the obligation to complete our
Phase IV long-term AK study, we determined that Phase II corporate studies on
other dermatology indications should be put on hold until such time as
increasing revenues and/or other


9


clinical data make such trials justifiable. However, DUSA is continuing to
support a wide range of independent investigator studies using the Levulan(R)
Kerastick(R) that could lead to new indications for future development.

Actinic Keratoses (AKs). AKs are superficial precancerous skin lesions
usually appearing as rough, scaly patches of skin with some underlying redness.
The traditional methods of treating AKs are cryotherapy, or the freezing of
skin, using liquid nitrogen; and 5-fluorouracil cream, or 5-FU. Although both
methods can be effective, each has limitations and can result in significant
side effects. Cryotherapy is non-selective, is usually painful at the site of
freezing and can cause blistering and loss of skin pigmentation, leaving white
spots. In addition, because there is no standardized treatment protocol, results
are not uniform. 5-FU can be highly irritating and requires twice-a-day
application by the patient for approximately 2 to 4 weeks, resulting in
inflammation, redness and erosion or rawness of the skin. Following the
treatment, an additional 1 to 2 weeks of healing is required. Our approved
treatment method involves applying Levulan(R) 20% topical solution using the
Kerastick(R) to the AK lesions, followed 14 to 18 hours later with exposure to
our BLU-U(R) for approximately 17 minutes. In 2001, we successfully completed
the first of two Phase IV trials required by the Food and Drug Administration,
or FDA, testing for allergic skin reactions to our therapy. The second trial,
which began in 2002, to evaluate the long-term effects of our therapy, is
currently underway. We have also started development activities in order to
commence clinical trials which, if successful, could support a broader AK
indication to enhance the Levulan(R) product line.

As of March 1, 2003, a new national reimbursement code for Medicare and
other third party payors for the BLU-U(R) application procedure, and the cost of
the Levulan(R) Kerastick(R), became effective. Doctors can also bill for any
applicable visit fees. However, some physicians have suggested that even the new
reimbursement levels still do not fully reflect the required efforts to
routinely execute our therapy in their practices. In addition, others have
reported problems prior to March 1, 2003 of receiving reimbursement at
previously approved levels, or at all. These issues have affected the economic
competitiveness with other AK therapies and have hindered the adoption of our
therapy in many cases. Accordingly, we are continuing to support efforts to
improve reimbursement levels to physicians, working with the major private
insurance carriers to reimburse our therapy, and are attempting to resolve
related billing and payment issues. We are hopeful that the recent changes to
reimbursement, plus future improvements, along with our education and marketing
programs, will help make Levulan(R) PDT a common therapy for AKs over time.

Onychomycosis. This condition is more commonly known as nail fungus.
Current topical therapies are only effective in a small percentage of patients.
Oral prescription medications are more


10


effective but must be taken over 12 weeks or more, and can pose risks of
systemic side effects such as liver disease and/or adverse interactions with
other medications. DUSA and its former marketing partner commenced a
vehicle-controlled, randomized, multicenter clinical feasibility trial for this
indication in 2001. Levulan(R) 20% topical solution or vehicle was applied to
infected toenails, followed in 3 to 6 hours by exposure to broadband red
light. Results from the Phase I/II study on onychomycosis indicated that
Levulan(R) PDT, as used in that study, was not successful in treating the
disease in the majority of patients. The Company believes that with some
adjustments to the protocol, Levulan(R) PDT might still be an effective
treatment for this disease. However, further Phase II development of this
indication is not planned at this time.

Persistent Hand and Foot Warts. Warts, which are characterized by abnormal
epidermal skin cell growth, are a common skin condition caused by the human
papilloma virus. Warts are usually treated first with over-the-counter salicylic
acid preparations. Often, these treatments are successful. However, in cases
where the warts do not clear, patients commonly consult a physician. The
physician's next line of therapy is usually cryotherapy with liquid nitrogen,
which is applied by the doctor every 1-4 weeks for anywhere from weeks to
months, or even years in rare cases. This treatment is painful and can
occasionally leave scars. Some dermatologists use lasers to treat warts,
although this process can also take many treatments with no guarantee of
success. Sometimes warts still persist despite all attempts at treatment. Warts
that have been present for a year or more, despite therapy, are termed
recalcitrant warts.

In a 1999 independent Danish randomized clinical trial using ALA PDT on 30
patients with 250 recalcitrant warts, the investigator reported that one of the
treatment groups showed a 70% elimination of recalcitrant warts through a
12-month period. In 2001, together with our former marketing partner, we began a
vehicle-controlled, randomized, multicenter clinical feasibility trial, to
enroll 64 patients with plantar warts persisting after a single standard
treatment. The trial involved applying Levulan(R) to the warts followed either 3
to 6 or 16 to 24 hours later by light treatment using a broadband red light.
Patients received up to 3 retreatments of partially responding and
non-responding warts at two-week intervals.

Although this study was not designed to be statistically significant, DUSA
believes that this data, combined with published independent results, are
sufficient to justify continued development of this indication at some time in
the future. However, further Phase II development for this indication is not
planned at this time.

Acne. Acne is a common skin condition caused by the blockage and/or
inflammation of sebaceous (oil) glands. Traditional treatments for mild to
moderate facial inflammatory acne include


11


over-the-counter topical medications for mild cases, and prescription topical
medications or oral antibiotics for mild to moderate cases. An oral retinoid
drug called Accutane(R)(1) is the most commonly prescribed treatment for cystic
acne and can also be used for moderate to severe inflammatory acne.
Over-the-counter treatments are not effective for many patients and can result
in side effects including drying, flaking and redness of the skin. Prescription
antibiotics lead to improvement in many cases, but patients must often take them
on a long-term basis. Accutane(R) can have a variety of side effects, from
dryness of the lips and joint pains, to birth defects, and elevated levels of
triglycerides and liver enzymes. With Levulan(R) PDT therapy for acne we would
be seeking to improve or clear patients' acne without the need for long-term
oral therapy and with fewer side effects than current therapies.

As part of the co-development program with our former partner, a dose-ranging
clinical trial was completed in 2001. However, the specific low dose protocol
tested was not able to replicate the positive clinical results seen in previous
independent research using higher drug doses but which also was associated with
significant side effects. Further Phase II development for this indication is
not planned at this time.

OTHER POTENTIAL DERMATOLOGY INDICATIONS

Facial Photodamaged Skin. Photodamaged skin, which is skin damaged by the
sun, occurs primarily in fair-skinned individuals after many years of sun
exposure. Signs of photodamaged skin include roughness, wrinkles and brown
spots. AKs also tend to occur in areas of photodamaged skin. There are numerous
consumer cosmetic and herbal products which claim to lessen or relieve the
symptoms of photodamaged skin. In most cases, there is little scientific data to
support these claims. The FDA has approved only one prescription drug,
Renova(R)(2), to treat this common skin condition. Patients generally use the
product for between 6 and 24 weeks before improvement may be observed. There are
also a number of FDA approved laser and light-based treatments being used in the
treatment of photodamaged skin.

As part of our AK clinical trials, we conducted a Phase II safety and
efficacy study, testing 64 patients with 3 to 7 AK lesions of the face or scalp
within an area of photodamaged skin. The physician investigators applied
Levulan(R) 20% topical solution over the entire area including the photodamaged
skin. After 14 to 18 hours, the patients were treated with blue light at
differing light

- ----------
(1) Accutane(R) is a registered trademark of Hoffmann-La Roche.

(2) Renova(R) is a registered trademark of Johnson & Johnson.



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doses. Investigators noted marked improvement in skin roughness in the treated
areas in two-thirds of the patients after treatment with Levulan(R) PDT as well
as some degree of improvement of wrinkles and brown spots. However, 10 of the 64
patients found that the burning and stinging of the PDT therapy was too
uncomfortable and as a result the treatment was either terminated early or the
light power was reduced. No patients reported a serious treatment-related
adverse event. Based on this data, we believe that this is a future potential
indication for Levulan(R) PDT.

There are numerous other potential uses for Levulan(R) PDT/PD in
dermatology. We are currently supporting, or may in the future support, research
in several of these areas, as appropriate, with corporate Phase I-III trials,
pilot trials, and/or investigator-sponsored studies, based on pre-clinical,
clinical, regulatory and marketing criteria we have established through our
strategic planning processes. Some of these potential uses in dermatology
include treatment of skin conditions such as psoriasis, photorejuvenation,
inflammatory acne, warts, molluscum contagiosum, oily skin, acne rosacea, and
cancers, such as squamous cell carcinomas and cutaneous T-cell lymphomas.

INTERNAL INDICATIONS

Barrett's Esophagus Dysplasia. Barrett's esophagus is an acquired
condition in which the normal tissue lining of the esophagus is replaced by
abnormal tissue in response to chronic exposure to stomach acid. Over time, the
area of the esophagus affected can develop dysplastic (precancerous) cells. As
the dysplasia progresses from low-grade to high-grade, the risk of esophageal
cancer increases significantly, such that patients with confirmed high-grade
dysplasia often undergo major surgery to remove the affected portion of the
esophagus. The condition is often undetected until the disease reaches later
stages.

There is currently no approved therapy to halt or reverse Barrett's
esophagus dysplasia, or to slow its progression to esophageal cancer. Current
medical treatment of the condition commonly includes lifelong anti-reflux
therapy with drugs called proton pump inhibitors to reduce stomach acid. A
current treatment for more advanced, precancerous, Barrett's esophagus involves
surgery to remove affected areas of the esophagus. At least one company has
filed a new drug application, or NDA, seeking approval of a PDT therapy for
Barrett's esophagus. See section entitled "Business - Competition". The role of
anti-reflux surgery, and/or medical devices is also being evaluated by the
medical community.

Independent European studies have reported that in late-stage Barrett's
esophagus the high-grade dysplasia can be destroyed by ALA PDT. In a randomized,
controlled European investigator study supported by DUSA, Levulan(R) PDT has
been shown to allow the conversion of early-stage


13


Barrett's esophagus with low-grade dysplasia and portions of Barrett's
esophageal lining back to normal esophageal lining.

During the second half of 2001, we started two Phase I/II studies for the
treatment of early and late-stage Barrett's esophagus, respectively, using
systemic Levulan(R) followed by red laser light in varying light doses. Patients
were randomized to receive various light doses, with retreatment if required,
and follow-up for 24 months after the initial treatment. In our clinical trial
in which the primary efficacy goal is the ablation of High Grade Dysplasia, or
HGD, in Barrett's esophagus (late stage Barrett's esophagus), 6 patients with
HGD have been treated with Levulan PDT. Of the 6 patients treated, 5 had
complete clearing of their areas of high-grade dysplasia, and 4 of those
patients have now been followed for a period greater than 1 year, indicating a
durable response. No esophageal scarring or ruptures were noted in the course of
this study. In our low-grade dysplasia (early stage) clinical trial in which the
primary efficacy goal is the conversion of Barrett's esophagus to normal
esophagus, 11 patients have been treated with Levulan PDT and are still being
followed. There was 1 patient in this study that had mild esophageal scarring
without symptoms. The most common adverse events in both studies were mild to
moderate nausea and vomiting. In order to control ongoing research and
development costs, we have chosen not to enroll any additional patients to these
studies, but will continue to follow the patients that have already been
treated.

Brain Cancer. Despite standard therapies that include surgical tumor
removal, radiation therapy, and chemotherapy, adult patients with the most
aggressive high-grade malignant brain tumor type, glioblastoma multiforme,
generally survive only 1 year. Independent European investigators have reported
that systemic ALA dosing before surgical resection of tumors resulted in
selective fluorescence of only the tumors. The normal white matter of the brain
showed no fluorescence. These investigators used ALA-induced fluorescence in a
study involving 52 patients with glioblastoma multiforme as a guide for the more
complete removal of tumors than would be possible using white light alone. This
technique is called fluorescence-guided resection.

In December 2002, we entered into a License and Development Agreement with
Photonamic GmbH & Co. KG, a recently formed subsidiary of medac GmbH, a German
pharmaceutical company. This agreement provides for the licensing to us of
Photonamic's proprietary technology related to ALA for systemic dosing in the
field of brain cancer. The technology provides DUSA with access to a systemic
formulation of ALA, and a significant amount of pre-clinical data, both of which
could also be useful and are also licensed to DUSA for certain other
indications, including Barrett's esophagus dysplasia. Photonamic is currently
conducting a European Phase III clinical trial in which ALA-induced fluorescence
is used to guide surgical tumor resection in patients suffering


14


from glioblastoma multiforme. European Phase III trial results may not be
acceptable by the FDA in the United States and we do not intend, at this time,
to repeat this study in the United States. These clinical trials are expected to
continue through late 2004 at a minimum, so safety and efficacy for the brain
cancer indication is still to be determined. See section entitled "Business -
Licenses".

OTHER POTENTIAL INTERNAL INDICATIONS

There may be numerous other potential therapeutic and cancer detection
uses for Levulan(R) PDT/PD, and we are currently supporting, or may in the
future support, research in several of these areas, as appropriate, with
corporate-sponsored clinical trials, and/or investigator-sponsored studies,
based on pre-clinical, clinical, regulatory and marketing criteria we have
established through our strategic planning processes. Some of the potential
non-dermatology indications include detection and/or treatment of
gastro-intestinal tumors, bladder cancer, pre-cancer and cancer of the oral
cavity, and pre-cancer and cancer of the larynx.

SUPPLY PARTNERS

National Biological Corporation. In November 1998, we entered into a
purchase and supply agreement with National Biological Corporation ("NBC") for
the manufacture of some of our light sources, including the BLU-U(R). We have
agreed to order from NBC all of our supply needs of these light sources for the
United States and Canada and NBC has agreed to supply us with the quantities we
order. If an opportunity arises, the parties have agreed to negotiate the terms
under which NBC would supply us with light sources for sale in countries other
than the current territories.

NBC has granted to us a license to manufacture the light sources if it
fails to meet our supply needs. Under these circumstances, we would also have a
worldwide license to import, use, sell or dispose of the light sources under
NBC's technology within the field of PDT. Also, NBC has agreed that it will not
supply light sources that may be used to compete with our business. In early
2001, we prepaid NBC for raw material costs in the amount of $400,000 associated
with our then current order. During 2002, the balance of this credit was applied
to other invoices and no amount remained outstanding at December 31, 2002. The
agreement has a 10-year term, subject to earlier termination for breach or
insolvency or for convenience. However, a termination for convenience requires
12 months' prior written notice.


15


North Safety Products. In September 1999, we entered into a purchase and
supply agreement with North Safety Products, Inc., or North, a unit of Norcross
Safety Products, LLC, for the manufacture and supply of our Kerastick(R) brand
applicator. In light of our decision to build our own manufacturing facilities
and since orders for Kerastick(R) units did not meet the parties' expectations,
the agreement was terminated on December 31, 2002. See section entitled
"Business - Manufacturing."

In anticipation of the termination of this agreement, DUSA ordered
approximately 45,000 Kerastick(R) units, which were delivered to DUSA during the
fourth quarter of 2002. This inventory is intended to meet product demand until
DUSA's manufacturing facility is approved by the FDA and functional, which is
expected in late 2003.

Sochinaz SA. Under an agreement dated December 24, 1993, Sochinaz SA
("Sochinaz") manufactures and supplies substantially all of our requirements of
Levulan(R) worldwide from its FDA approved facility in Switzerland. In June
2000, we amended the agreement to include an option to allow us to extend the
term for an additional 3 years until December 3, 2007. While we can obtain
alternative supply sources in certain circumstances, any new supplier would have
to be inspected and qualified by the FDA.

medac GmbH. In December 2002, we entered into a supply agreement with
medac GmbH in connection with the Photonamic license agreement mentioned above.
We have a license to market and sell the formulation exclusively in the United
States and in several other countries and non-exclusively in the rest of the
world subject to certain field limitations. The supply agreement covers medac's
current systemic dosage formulation for use in brain cancer, Barrett's
esophagus, if we require it, as well as for other mutually agreed upon
indications. The agreement provides for minimum purchase requirements following
our first commercial sale. In addition, the agreement has a term of 10 years
from the date of our first commercial sale, subject to earlier termination
rights, as well as successive one-year renewal terms.

LICENSES

PARTEQ Research and Development Innovations. We license the patents
underlying our Levulan(R) PDT/PD systems under a license agreement with PARTEQ
Research and Development Innovations ("PARTEQ"), the licensing arm of Queen's
University, Kingston, Ontario. Under the agreement, which became effective
August 27, 1991, we have been granted an exclusive worldwide license, with a
right to sublicense, under PARTEQ's method patent rights, to make, have made,
use and sell products which are precursors of PpIX, including ALA. The agreement
also covers any improvements discovered, developed or acquired by or for PARTEQ,
or Queen's University, to


16


which PARTEQ has the right to grant a license. A non-exclusive right is reserved
to Queen's University to use the subject matter of the agreement for
non-commercial educational and research purposes. A right is reserved to the
Department of National Defense Canada to use the licensed rights for defense
purposes including defense procurement but excluding sales to third-parties.

When we are selling our products directly, we have agreed to pay to PARTEQ
royalties of 6% and 4% on 66% of the net selling price in countries where patent
rights do and do not exist, respectively. In cases where we have a sublicensee,
we will pay 6% and 4% when patent rights do and do not exist, respectively, on
our net selling price less the cost of goods for products sold to the
sublicensee, and 6% of royalty payments we receive on sales of products by the
sublicensee. We are also obligated to pay 5% of any lump sum sublicense fees
paid to us, such as milestone payments, excluding amounts designated by the
sublicensee for future research and development efforts. The agreement is
effective for the life of the latest United States patents and becomes perpetual
and royalty-free when no United States patent subsists. Annual minimum royalties
to PARTEQ must total at least CDN $100,000 in order to retain the license. We
have the right to terminate the PARTEQ agreement with or without cause upon 90
days notice. See "Note 14(a) to the Company's Notes to the Consolidated
Financial Statements".

Together with PARTEQ and Draxis Health, Inc., our former parent, we
entered into an agreement (the "ALA Assignment Agreement") effective October 7,
1991. According to the terms of this agreement we assigned to Draxis our rights
and obligations under the license agreement to the extent they relate to Canada.
In addition, we have agreed to disclose to Draxis on an ongoing basis, any
technology which is available to us relating to the subject matter of the
license agreement which would assist Draxis in developing the Canadian market
under the assigned rights. Draxis is responsible for royalties which would
otherwise be payable by us in accordance with the license agreement for net
Canadian sales of products and sublicensing revenues. Draxis has also agreed to
pay us a royalty of 2% of net Canadian sales of products.

Photonamic GmbH & Co. KG. In December, we entered into a license and
development agreement with Photonamic GmbH & Co. KG, a recently formed
subsidiary of medac GmbH, a German pharmaceutical company. This agreement
provides for the licensing to us of Photonamic's proprietary technology related
to aminolevulinic acid (ALA), the compound we use in our Levulan(R) Photodynamic
Therapy (PDT) and Photodetection (PD).

Under the terms of the License and Development Agreement, we received a
license for the United States and several other countries, to use Photonamic's
technology, including pre-clinical and


17

clinical data, related to ALA for systemic dosing in the field of brain cancer,
and for indications which the parties may jointly develop during the term of
their collaboration. Additionally, we are entitled to use the pre-clinical data
for indications which we may develop on our own. Photonamic is currently
conducting a European Phase III clinical trial in which ALA-induced fluorescence
is used to guide surgical tumor resection in patients suffering from the most
aggressive form of adult brain tumor, glioblastoma multiforme. This clinical
trial is expected to continue through late 2004, at a minimum. We paid a
$500,000 up-front license fee, and will be obligated to pay certain regulatory
milestones and royalties on net sales of any brain cancer product which utilizes
the Photonamic technology. Should Photonamic's clinical study be successful, we
will be obligated to proceed with development of the product in the United
States in order to retain the license for the use of the technology in the
treatment of brain cancer. The agreement has a term of 10 years from the date of
first approval of a product using Photonamic's technology, subject to earlier
termination rights, as well as one-year renewal terms.

PATENTS AND TRADEMARKS

We actively seek, when appropriate, to protect our products and
proprietary information through United States and foreign patents, trademarks
and contractual arrangements. In addition, we rely on trade secrets and
contractual arrangements to protect certain of our proprietary information and
products.

Our ability to compete successfully depends, in part, on our ability to
defend our patents that have issued, obtain new patents, protect trade secrets
and operate without infringing the proprietary rights of others. We have no
product patent protection for the compound ALA itself, as our basic patents are
for methods of detecting and treating various diseased tissues using ALA or
related compounds called precursors, in combination with light. Even where we
have patent protection, there is no guarantee that we will be able to enforce
our patents. Patent litigation is expensive, and we may not be able to afford
the costs. We own or exclusively license patents and patent applications related
to the following:

- unique physical forms of ALA,

- methods of using ALA and its unique physical forms in combination
with light, and

- compositions and apparatus for those methods.

These patents expire no earlier than 2009, and certain patents are
entitled to terms beyond that date.


18


Under the license agreement with PARTEQ and Draxis, we hold an exclusive
worldwide license to certain patent rights in the United States and a limited
number of foreign countries. See section entitled "Business - Licenses." All
United States patents and patent applications licensed from PARTEQ relating to
ALA are method of treatment patents. Method of treatment patents limit direct
infringement to users of the methods of treatment covered by the patents. We
currently have patents and/or pending patent applications in the United States
and in a number of foreign countries covering unique physical forms of ALA,
compositions containing ALA, as well as ALA applicators, light sources for use
with ALA, and other technology. We cannot guarantee that any pending patent
applications will mature into issued patents.

We have limited patent protection outside the United States, which may
make it easier for third-parties to compete there. Our basic method of treatment
patents and applications have counterparts in only four foreign countries, two
of which are the subject of legal action. See sections entitled "Risk Factors -
Risks Related to DUSA"; and "Legal Proceedings".

Japanese Patent No. 273032, which we have licensed from PARTEQ, relates to
our basic methods of use. While this patent was opposed and the Japanese Patent
Office Board of Appeals revoked this patent, the patent was subsequently
restored, in amended form, by the Japanese Patent Office. This restoration of
Japanese Patent 2731032 resulted from successful pursuit of an appeal of the
revocation before the Tokyo High Court.

We can give no assurance that a third-party or parties will not claim
(with or without merit) that we have infringed or misappropriated their
proprietary rights. A number of entities have obtained, and are attempting to
obtain patent protection for various uses of ALA. We can give no assurances as
to whether any issued patents, or patents that may later issue to third-parties,
may affect the uses on which we are working or whether such patents can be
avoided, invalidated or licensed if they cannot be avoided or invalidated. If
any third-party were to assert a claim for infringement, we can give no
assurances that we would be successful in the litigation or that such litigation
would not have a material adverse effect on our business, financial condition
and results of operation. Furthermore, we may not be able to afford the expense
of defending against such a claim.

In addition, we cannot guarantee that our patents, whether owned or
licensed, or any future patents that may issue, will prevent other companies
from developing similar or functionally equivalent products. Further, we cannot
guarantee that we will continue to develop our own patentable technologies or
that our products or methods will not infringe upon the patents of
third-parties. In addition, we cannot guarantee that any of the patents that may
be issued to us will effectively protect our technology or provide a competitive
advantage for our products or will not be challenged, invalidated, or
circumvented in the future.

We also attempt to protect our proprietary information as trade secrets.
Generally agreements with each employee, licensing partner, consultant,
university, pharmaceutical company and agent contain provisions designed to
protect the confidentiality of our proprietary information. However, we can give
no assurances that these agreements will provide effective protection for our
proprietary information in the event of unauthorized use or disclosure of such
information. Furthermore, we can


19


give no assurances that our competitors will not independently develop
substantially equivalent proprietary information or otherwise gain access to our
proprietary information, or that we can meaningfully protect our rights in
unpatentable proprietary information.

Even in the absence of composition of matter patent protection for ALA, we
may receive financial benefits from: (i) patents relating to the use of such
product (like PARTEQ's patents); (ii) patents relating to special compositions
and formulations; and (iii) limited marketing exclusivity that may be available
as a patent term extension under the Hatch/Waxman Act and any counterpart
protection available in foreign countries. See section entitled "Business -
Government Regulation." Effective patent protection also depends on many other
factors such as the nature of the market and the position of the product in it,
the growth of the market, the complexities and economics of the process for
manufacture of the active ingredient of the product and the requirements of the
new drug provisions of the Food, Drug and Cosmetic Act, or similar laws and
regulations in other countries.

We seek registration of trademarks in the United States, and other
countries where we may market our products. To date, we have been issued 22
trademark registrations, and other applications are pending.

MANUFACTURING

Historically, our drug, Levulan(R), the Kerastick(R) brand applicator and
the BLU-U(R) brand light source were each manufactured by a single third-party
supplier. See section entitled "Business - Supply Partners."

Contemporaneously with an amendment of our agreement with North, which
provided for early termination of the current Kerastick(R) manufacturing
arrangement, and in order to meet our obligations to our former dermatology
marketing partner, we decided to build a Kerastick(R) manufacturing line at our
Wilmington facility. We believe that the development of our own manufacturing
capabilities will enable us to better manage and control the costs of
production; however, until product sales increase significantly our unit cost
per Kerastick(R) at our new facility will be higher. The construction process is
now complete and FDA inspection is expected during 2003. We anticipate that our
current inventory levels will meet product demand until our new manufacturing
facility is approved by the FDA and functional.

DISTRIBUTION

As of September 1, 2002, DUSA engaged Moore Medical Corporation, a
national distributor and marketer of medical and surgical supplies, to be its
exclusive distributor of the Kerastick(R) in the


20


United States. The agreement has a one-year term, which can be automatically
renewed for additional one-year terms, unless either party notifies the other
party prior to a term expiration that it does not intend to renew the agreement.
In addition, either party may terminate the agreement earlier, on certain terms,
or in the event that the other party shall have materially breached any of its
obligations in the agreement.

MARKETING AND SALES

Under our agreement with our former dermatology marketing partner,
marketing and sales of Levulan(R) PDT products were the responsibility of the
partner. As a result of the termination of that relationship, we are in the
process of implementing our own marketing, education, and development strategy.
For now, we have decided not to create a nationwide sales force, or to seek a
new dermatology marketing partner. Instead, we are focusing on establishing a
clear position for our therapy in the marketplace, meeting the needs of
dermatologists, and educating them about the benefits of our therapy, in an
effort to increase product sales over time. This is being accomplished through
the support of medical education activities, participation in dermatology
conferences, support of Company-sponsored research and development efforts and
independent investigator studies, and support of efforts to improve third party
reimbursement.

Draxis holds the rights to market Levulan(R) PDT in Canada. See section
entitled "Business - Licenses." The Health Protection Branch - Canada has
granted marketing approval for the Levulan(R) Kerastick(R) with PDT using the
BLU-U(R) for AKs of the face or scalp and we have had discussions with Draxis to
establish a supply arrangement for the Canadian market. However, Draxis has not
yet indicated if or when they might begin marketing our products in Canada.

COMPETITION

Commercial development of PDT agents other than Levulan(R) is currently
being pursued by a number of companies. These include: QLT PhotoTherapeutics
Inc. (Canada); Axcan Pharma Inc. (U.S.); Miravant, Inc. (U.S.); and
Pharmacyclics, Inc. (U.S.). We are also aware of several companies conducting
research with ALA or ALA-related compounds, including: medac GmbH and Photonamic
GmbH & Co. KG (Germany); and PhotoCure ASA (Norway) who entered into a marketing
agreement with Galderma S.A. for countries outside of Nordic countries for
certain dermatology indications.

PhotoCure has received marketing approval of its ALA precursor (ALA
methyl-ester) compound with PDT for the treatment of AK in the European Union,
New Zealand, and countries in Scandinavia. PhotoCure has also filed for
regulatory approvals in Australia and the United States. In


21


the United States, PhotoCure has received a notice of approvability from the
FDA. Upon PhotoCure receiving approval from the FDA to market its product in the
United States, its entry into the marketplace will likely represent direct
competition for our products. In April 2002, we received a copy of a notice
issued by PhotoCure ASA to Queen's University at Kingston, Ontario, alleging
that Australian Patent No. 624985, which is one of the patents covered by our
agreement with PARTEQ, relating to 5-aminolevulinic acid technology, is invalid.
As a consequence of this action, Queen's University has assigned the Australian
patent to us so that we may participate directly in this litigation. We filed an
answer setting forth our defenses and a related countersuit alleging that
PhotoCure's activities infringe the patent. The case is in its earliest stages
so we are unable to predict the outcome at this time, but our intention is to
vigorously defend our intellectual property. See section entitled "Business -
Legal Proceedings".

In December 2002, Axcan Pharma Inc. announced that it had received a
notice of approvability from the FDA for the use of its product,
PHOTOFRIN(R)(3), for photodynamic therapy in the treatment of high grade
dysplasia associated with Barrett's esophagus. Axcan reported that it expects a
final approval of its new drug application within the next few months. The
approval would allow Axcan to be the first to market a PDT therapy for this
indication, which we are also pursuing.

The pharmaceutical industry is highly competitive. Many of our competitors
have substantially greater financial, technical and marketing resources than we
have. In addition, several of these companies have significantly greater
experience than we do in developing products, conducting preclinical and
clinical testing and obtaining regulatory approvals to market products for
health care. Our competitors may succeed in developing products that are safer
or more effective than ours and in obtaining regulatory marketing approval of
future products before we do. Our competitiveness may also be affected by our
ability to manufacture and market our products and by the level of reimbursement
for the cost of our drug and treatment by third-party payors, such as insurance
companies, health maintenance organizations and government agencies.

We believe that comparisons of the properties of various photosensitizing
PDT drugs will also highlight important competitive issues. We expect that our
principal methods of competition with other PDT companies will be based upon
such factors as the ease of administration of our photodynamic therapy; the
degree of generalized skin sensitivity to light; the number of required doses;
the selectivity of our drug for the target lesion or tissue of interest; and the
type and cost of our light systems. New drugs or future developments in PDT,
laser products or in other drug

- ----------
(3) PHOTOFRIN(R) is a registered trademark of Axcan Pharma Inc.

22


technologies may provide therapeutic or cost advantages for competitive
products. No assurance can be given that developments by other parties will not
render our products uncompetitive or obsolete.

Our current primary competitors for our first products are the existing
therapies for treatment of AKs. See section entitled "Business - Dermatology
Indications, Actinic Keratoses." Our principal method of competition with these
therapies is patient benefits, including rapid healing and excellent cosmetic
results.

GOVERNMENT REGULATION

The manufacture and sale of pharmaceuticals and medical devices in the
United States are governed by a variety of statutes and regulations. These laws
require, among other things:

- approval of manufacturing facilities, including adherence to current
good manufacturing, laboratory and clinical practices during
production and storage known as cGMPs, GLPs and GCPs respectively,

- controlled research and testing of products,

- applications for marketing approval containing manufacturing,
preclinical and clinical data to establish the safety and efficacy
of the product, and

- control of marketing activities, including advertising and labeling.

The marketing of pharmaceutical products requires the approval of the FDA
in the United States, and similar agencies in other countries. The FDA has
established regulations and safety standards, which apply to the preclinical
evaluation, clinical testing, manufacture and marketing of pharmaceutical
products. The process of obtaining marketing approval for a new drug normally
takes several years and often involves significant costs. The steps required
before a new drug can be produced and marketed for human use in the United
States include:

- preclinical studies

- the filing of an Investigational New Drug, or IND, application,

- human clinical trials, and

- the approval of a New Drug Application, or NDA.

Preclinical studies are conducted in the laboratory and on animals to
obtain preliminary information on a drug's efficacy and safety. The time
required for conducting preclinical studies varies greatly depending on the
nature of the drug, and the nature and outcome of the studies. Such studies can
take many years to complete. The results of these studies are submitted to the
FDA as part of the IND application. Human testing can begin if the FDA does not
object to the IND application.


23


The human clinical testing program involves three phases. Each clinical
study typically is conducted under the auspices of an Institutional Review
Board, or IRB, at the institution where the study will be conducted. An IRB will
consider among other things, ethical factors, the safety of human subjects, and
the possible liability of the institution. A clinical plan, or "protocol," must
be submitted to the FDA prior to commencement of each clinical trial. All
patients involved in the clinical trial must provide informed consent prior to
their participation. The FDA may order the temporary or permanent discontinuance
of a clinical trial at any time for a variety of reasons, particularly if safety
concerns exist. These clinical studies must be conducted in conformance with the
FDA's bioresearch monitoring regulations.

In Phase I, studies are usually conducted on a small number of healthy
human volunteers to determine the maximum tolerated dose and any product-related
side effects of a product. Phase I studies generally require several months to
complete, but can take longer, depending on the drug and the nature of the
study. Phase II studies are conducted on a small number of patients having a
specific disease to determine the most effective doses and schedules of
administration. Phase II studies generally require from several months to 2
years to complete, but can take longer, depending on the drug and the nature of
the study. Phase III involves wide scale studies on patients with the same
disease in order to provide comparisons with currently available therapies.
Phase III studies generally require from 6 months to 4 years to complete, but
can take longer, depending on the drug and the nature of the study.

Data from Phase I, II and III trials are submitted to the FDA with the
NDA. The NDA involves considerable data collection, verification and analysis,
as well as the preparation of summaries of the manufacturing and testing
processes and preclinical and clinical trials. Submission of an NDA does not
assure FDA approval for marketing. The application review process generally
takes 1 to 4 years to complete, although reviews of treatments for AIDS, cancer
and other life-threatening diseases may be accelerated, expedited or subject to
fast track treatment. The process may take substantially longer if, among other
things, the FDA has questions or concerns about the safety and/or efficacy of a
product. In general, the FDA requires properly conducted, adequate and
well-controlled clinical studies demonstrating safety and efficacy with
sufficient levels of statistical assurance. However, additional information may
be required. For example, the FDA also may request long-term toxicity studies or
other studies relating to product safety or efficacy. Even with the submission
of such data, the FDA may decide that the application does not satisfy its
regulatory criteria for approval and may disapprove the NDA. Finally, the FDA
may require additional clinical tests following NDA approval to confirm safety
and efficacy, often referred to as Phase IV clinical trials.


24


Upon approval, a prescription drug may only be marketed for the approved
indications in the approved dosage forms and at the approved dosage with the
approved labeling. Adverse experiences with the product must be reported to the
FDA. In addition, the FDA may impose restrictions on the use of the drug that
may be difficult and expensive to administer. Product approvals may be withdrawn
if compliance with regulatory requirements is not maintained or if problems
occur or are discovered after the product reaches the market. After a product is
approved for a given indication, subsequent new indications, dosage forms, or
dosage levels for the same product are reviewed by the FDA after the filing and
upon approval of a supplemental NDA. The supplement deals primarily with safety
and effectiveness data related to the new indication or dosage. Finally, the FDA
requires reporting of certain safety and other information, often referred to as
"adverse events" that become known to a manufacturer of an approved drug. If an
active ingredient of a drug product has been previously approved, drug
applications can be filed that may be less time-consuming and costly.

On December 3, 1999, the FDA approved the marketing of our Levulan(R)
Kerastick(R) 20% Topical Solution with PDT for treatment of AKs of the face or
scalp. The commercial version of our BLU-U(R) was approved on September 26,
2000.

We are currently conducting Phase I/II studies to examine the use of ALA
for the treatment of Barrett's esophagus with areas of high-grade dysplasia.
Other than the FDA-approved use of the Levulan(R) Kerastick(R) with PDT for
treatment of AKs, our other potential products still require significant
development, including additional preclinical and/or clinical testing, and
regulatory marketing approval prior to commercialization. The process of
obtaining required approvals can be costly and time consuming and there can be
no guarantee that the use of Levulan(R) in any future products will be
successfully developed, prove to be safe and effective in clinical trials, or
receive applicable regulatory marketing approvals.

Medical devices, such as our light source device, are also subject to the
FDA's rules and regulations. These products are required to be tested,
developed, manufactured and distributed in accordance with FDA regulations,
including good manufacturing, laboratory and clinical practices. Under the Food,
Drug & Cosmetic Act, all medical devices are classified as Class I, II or III
devices. The classification of a device affects the degree and extent of the
FDA's regulatory requirements, with Class III devices subject to the most
stringent requirements and FDA review. Generally, Class I devices are subject to
general controls (for example, labeling and adherence to the cGMP requirement
for medical devices), and Class II devices are subject to general controls and
special controls (for example, performance standards, postmarket surveillance,
patient registries and FDA guidelines). Class III devices, which typically are
life-sustaining or life-supporting and implantable devices, or new devices that
have been found not to be substantially equivalent to a legally marketed Class I
or Class II "predicate device," are subject to general controls and also require
clinical testing


25


to assure safety and effectiveness before FDA approval is obtained. The FDA also
has the authority to require clinical testing of Class I and II devices. The
BLU-U(R) has been classified as a Class III device. We are developing a device
for the Barrett's esophagus indication which we believe will also be classified
as Class III and be subject to the highest level of FDA regulation. Approval of
Class III devices require the filing of a PMA application supported by extensive
data, including preclinical and clinical trial data, to demonstrate the safety
and effectiveness of the device. If human clinical trials of a device are
required and the device presents a "significant risk," the manufacturer of the
device must file an investigational device exemption or "IDE" application and
receive FDA approval prior to commencing human clinical trials. At present, our
devices are being studied in preclinical and clinical trials under our INDs.

Following receipt of the PMA application, if the FDA determines that the
application is sufficiently complete to permit a substantive review, the agency
will accept it for filing and further review. Once the submission is filed, the
FDA begins a review of the PMA application. Under the Food, Drug and Cosmetics
Act, the FDA has 180 days to review a PMA application. The review of PMA
applications more often occur over a significantly protracted time period, and
the FDA may take up to 2 years or more from the date of filing to complete its
review.

The PMA process can be expensive, uncertain and lengthy. A number of other
companies have sought premarket approval for devices that have never been
approved for marketing. The review time is often significantly extended by the
FDA, which may require more information or clarification of information already
provided in the submission. During the review period, an advisory committee
likely will be convened to review and evaluate the PMA application and provide
recommendations to the FDA as to whether the device should be approved for
marketing. In addition, the FDA will inspect the manufacturing facility to
ensure compliance with cGMP requirements for medical devices prior to approval
of the PMA application. If granted, the premarket approval may include
significant limitations on the indicated uses for which the product may be
marketed, and the agency may require post-marketing studies of the device.

Medical products containing a combination of drugs, including biologic
drugs, or devices may be regulated as "combination products" in the United
States. A combination product generally is defined as a product comprised of
components from 2 or more regulatory categories (drug/device, device/biologic,
drug/biologic, etc.). In December 2002, the FDA established the Office of
Combination Products, or OCP, whose responsibilities, according to the FDA, will
cover the entire regulatory life cycle of combination products, including
jurisdiction decisions as well as the timeliness and effectiveness of pre-market
review, and the consistency and appropriateness of post-market regulation.


26


In connection with our NDA for the Levulan(R) Kerastick(R) with PDT for
AKs, a combination filing (including a PMA for the BLU-U(R) light source device
and the NDA for the Levulan(R) Kerastick(R)) was submitted to the Center for
Drug Evaluation and Research. The PMA was then separated from the NDA submission
by the FDA and reviewed by the FDA's Center for Devices and Radiological Health.
Based upon this experience, we anticipate that any future NDAs for Levulan(R)
PDT/PD will be a combination filing accompanied by PMAs. There is no guarantee
that PDT products will continue to be regulated as combination products.

The United States Drug Price Competition and Patent Term Restoration Act
of 1984 known as the Hatch-Waxman Act, provides for the return of up to 5 years
of patent term for a patent that covers a new product or its use, to compensate
for time lost during the regulatory review process. The application for patent
term extension is subject to approval by the U.S. Patent and Trademark Office in
conjunction with the FDA. It may take many months to obtain approval of the
application for patent term extension, and there can be no guarantee that the
application will be granted. We believe that the FDA's December 3, 1999 approval
of our NDA for the Levulan(R) Kerastick(R) with PDT is the first marketing
approval for a medical use of ALA. We therefore believe that this approval may
form the basis for extending the term of one of our patents. However, there can
be no assurance that we will receive a patent term extension.

The Hatch-Waxman Act also establishes a 5 year period of marketing
exclusivity from the date of NDA approval for new chemical entities approved
after September 24, 1984. Levulan(R) is a new chemical entity and market
exclusivity under this law will expire on December 3, 2004. During this
Hatch-Waxman marketing exclusivity period, no third-party may submit an
"abbreviated NDA" or "paper NDA" to the FDA.

Finally, any abbreviated or paper NDA applicant will be subject to the
notification provisions of the Hatch-Waxman Act, which should facilitate our
notification about potential infringement of our patent rights. The abbreviated
or paper NDA applicant must notify the NDA holder and the owner of any patent
applicable to the abbreviated or paper NDA product, of the application and
intent to market the drug that is the subject of the NDA.

Over time, we also intend to market our products outside of the United
States. Generally, we try to design our protocols for clinical studies so that
the results can be used in all the countries where we hope to market the
product. However, countries sometimes require additional studies to be conducted
on patients located in their country. Prior to marketing a product in other
countries, approval by that nation's regulatory authorities must be obtained.
Our former marketing partner was responsible for applying for marketing
approvals outside the United States for Levulan(R) PDT for dermatology uses and
did file applications for approval in Austria, Australia, South Africa and


27


Brazil. However, as we have determined that we should concentrate solely on the
United States market at this time, we authorized our former partner to withdraw
the application for regulatory approval of Levulan(R) PDT in Australia, and have
now followed the same course for the applications in Austria and South Africa.
The approvals for the Levulan(R) Kerastick(R) and BLU-U(R) in Brazil are being
transferred to us and we intend to maintain these registrations. The regulatory
approvals for Canada held by Draxis Health, Inc. will not be affected.

With the enactment of the Drug Export Amendments Act of the United States
in 1986, products not yet approved in the United States may be exported to
certain foreign markets if the product is approved by the importing nation and
approved for export by the United States government. We can give no assurance
that we will be able to get approval for any of our potential products from any
importing nations' regulatory authorities or be able to participate in the
foreign pharmaceutical market.

Our research and development activities have involved the controlled use
of certain hazardous materials, such as mercury in fluorescent tubes. While we
do not currently manufacture any products, we are subject to various laws and
regulations governing the use, manufacture, storage, handling and disposal of
hazardous materials and certain waste products. During the design, construction
and validation phases of our new Kerastick(R) facility, we have taken steps to
ensure that appropriate environmental controls associated with the facility
comply with environmental laws and standards. We can give no assurance that we
will not have to make significant additional expenditures in order to comply
with environmental laws and regulations in the future. Also, we cannot assure
that current or future environmental laws or regulations will not materially
adversely effect our operations, business or assets. In addition, although we
believe that our safety procedures for the handling and disposal of such
materials comply with the standards prescribed by current environmental laws and
regulations, the risk of accidental contamination or injury from these materials
cannot be completely eliminated. In the event of such an accident, we could be
held liable for any damages that result, and any such liability could exceed our
resources.

PRODUCT LIABILITY AND INSURANCE

We are subject to the inherent business risk of product liability claims
in the event that the use of our technology or any prospective product is
alleged to have resulted in adverse effects during testing or following
marketing approval of any such product for commercial sale. We maintain product
liability insurance for coverage of our clinical trial activities and for our
commercial supplies. There can be no assurance that such insurance will continue
to be available on commercially reasonable terms or that it will provide
adequate coverage against all potential claims.


28


EMPLOYEES

At the end of 2002, we had 43 full-time employees. Our staffing levels for
key management personnel in administrative, financial, technical and operations
functions had been established to support the sales levels of Levulan(R) PDT
that did not materialize. However, following the reacquisition of our product
rights, we downsized our staffing levels by approximately 20%. Also, during the
fourth quarter of 2002, both our Vice President of Regulatory Affairs and Vice
President of Business Development ended their employment with us. However, they
are both consulting on a part-time, as needed, basis. We have employment
agreements with our key executive officers. We have purchased, and are the named
beneficiary of, a key man life insurance policy having a face value of CDN
$2,000,000 on the life of our President. We also retain numerous independent
consultants and the services of key researchers at leading university centers
whose activities are coordinated by our employees. For example, in June 2002,
the Company renewed its master service agreement, effective June 15, 2001, with
Therapeutics, Inc. to manage the clinical development of DUSA's products in the
field of dermatology. We intend to hire other employees and consultants as
needed.

INTERNET INFORMATION

Our internet site is located at www.dusapharma.com. Copies of our reports
filed pursuant to Section 13(a) or 15(d) of the Exchange Act, including Annual
Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form
8-K may be accessed from our website, free of charge, as soon as reasonably
practicable after we electronically file such reports with, or furnish such
reports to, the Securities and Exchange Commission.

RISK FACTORS

This section of our Annual Report on Form 10-K contains forward-looking
statements that involve risks and uncertainties, such as statements of our
plans, objectives, expectations and intentions. We use words such as
"anticipate," "believe," "expect," future" and "intend" and similar expressions
to identify forward-looking statements. Our actual results could differ
materially from those anticipated in these forward-looking statements for many
reasons, including the factors described below and elsewhere in this Annual
Report. You should not place undue reliance on these forward-looking statements,
which apply only as of the date of this Annual Report.

The following are among the risk factors we face related to our business,
assets and operations. They are not the only ones we face. Additional risks and
uncertainties that we are not aware of or that we currently deem immaterial also
may impair our business. If any of the following risks actually occur, our
business, financial condition and operating results could be materially
adversely affected.


29


RISKS RELATED TO DUSA

WE ARE NOT CURRENTLY PROFITABLE AND MAY NOT BE PROFITABLE IN THE FUTURE UNLESS
WE CAN SUCCESSFULLY MARKET AND SELL OUR FIRST PRODUCT, THE LEVULAN(R)
KERASTICK(R) WITH PDT FOR THE TREATMENT OF AKS OF THE FACE OR SCALP.

WE HAVE ONLY LIMITED EXPERIENCE MARKETING OR SELLING DERMATOLOGY PRODUCTS
AND, AS A RESULT, OUR REVENUES FROM PRODUCT SALES MAY SUFFER.

The commercial success of Levulan(R) Kerastick(R) with PDT for AKs of the
face or scalp will partly depend on the effective marketing of our products in
the United States, and we have only limited marketing experience selling
dermatology products in the United States or elsewhere. Effective September 1,
2002, DUSA and our former marketing partner terminated the parties' marketing,
development and supply agreement. As a result of this termination, DUSA
reacquired all rights it granted under the agreement. For now, DUSA has decided
not to create a nationwide sales force, or to seek a new dermatology marketing
partner. Instead, DUSA intends to focus on establishing a clear position for our
therapy in the marketplace, meeting the needs of dermatologists, and educating
them about the benefits of our therapy, in an effort to increase product sales
over time. This will be accomplished through the support of medical education
activities, participation in dermatology conferences, support of
Company-sponsored research and development efforts and independent investigator
studies, and support of efforts to improve third party reimbursement. If these
efforts fail, then sales of the Kerastick(R) will be adversely affected. During
2003, we intend to conduct some limited regional test marketing strategies.
Depending on the responses, we may consider developing a sales force of our own.
If we do establish a marketing and sales force capability, it will involve
significant expense, and we will be doing so without the experience of having
marketed pharmaceutical products in the past.

IF PRODUCT SALES DO NOT INCREASE SIGNIFICANTLY OR IF WE DO NOT OBTAIN
ADDITIONAL FUNDING, WE WILL NOT BE ABLE TO ADVANCE OUR OTHER POTENTIAL
DEVELOPMENT PROGRAMS AS QUICKLY AS WE WOULD LIKE TO, WHICH WOULD DELAY THE
APPROVAL PROCESS AND MARKETING OF NEW POTENTIAL PRODUCTS.

The development and commercialization process is costly and delays and/or
unanticipated costs could adversely affect our financial condition. If we do not
generate sufficient revenues from our approved products, there can be no
guarantee that we will obtain the funding resources necessary


30


to continue the development of our potential dermatology and/or other products,
as such requirements would require DUSA to commit substantially greater capital
than we have to research and development of such products and we may not have
sufficient funds to complete all of our programs.

IF WE CANNOT IMPROVE PHYSICIAN REIMBURSEMENT AND/OR CONVINCE MORE PRIVATE
INSURANCE CARRIERS TO REIMBURSE PHYSICIANS FOR OUR THERAPY, ADOPTION OF
OUR THERAPY MAY SUFFER.

As of March 1, 2003, the national reimbursement code for Medicare and
other third-party payors for the BLU-U(R) application procedure, and for the
costs of the Levulan(R) Kerastick(R), became effective. Doctors can also bill
for any applicable visit fees. However, some physicians have suggested that even
the new reimbursement levels still do not fully reflect the required efforts to
routinely execute our therapy in their practices. In addition, others have
reported problems prior to March 1, 2003 of receiving reimbursement at
previously approved levels, or at all. These issues have affected the economic
competitiveness of our products with other AK therapies and hence have hindered
the adoption of our therapy in many cases. Accordingly, we are continuing to
support efforts to improve reimbursement levels to physicians, working with the
major private insurance carriers to reimburse our therapy, and are attempting to
resolve related billing and payment issues. We are hopeful that the recent
changes to reimbursement, plus future improvements, along with our education and
marketing programs, will help make Levulan(R) PDT a common therapy for AKs over
time. However, if improvements are not made to reimbursement, adoption of our
therapy will suffer.

SINCE WE RELY HEAVILY ON OUTSIDE CONTRACTORS AS SOLE SUPPLIERS AND
MANUFACTURERS OF LEVULAN(R) AND BLU-U(R), AND HAVE RECENTLY TERMINATED OUR
AGREEMENT WITH OUR OUTSIDE KERASTICK(R) MANUFACTURER, AND DO NOT YET HAVE
OUR OWN KERASTICK(R) MANUFACTURING FACILITY APPROVED BY THE FDA, OUR
MARKETING EFFORTS AND SALES MAY SUFFER IF OUR EXISTING SUPPLY OF PRODUCT
FAILS IN ANY WAY TO ADEQUATELY PROVIDE US THE QUALITY AND QUANTITY OF THE
PRODUCTS WE NEED.

We are not currently approved to manufacture any of our products on our
own. We have terminated our agreement with our outside Kerastick(R)
manufacturer, and are in the process of validating our own Kerastick(R)
manufacturing facility. However, we have not yet had our facility approved by
the FDA, and have not yet produced commercial quantities of Kerastick(R) units
in the facility. We also have only one source for both Levulan(R) and the
BLU-U(R). We have not ordered any new BLU-U(R) units since 2001. Manufacturers,
and/or their subcontractors, often encounter difficulties when products are
manufactured for the first time, re-starting production after a long lay-off, or
large quantities of new products are manufactured, including problems involving:


31


- product yields,

- quality control,

- component and service availability,

- compliance with FDA regulations, and

- the need for further FDA approval if manufacturers make material
changes to manufacturing processes and/or facilities.

We cannot guarantee that problems will not arise with production yields,
costs or quality as we seek to commence, re-start or increase production. Any
manufacturing problems could delay or limit our supplies or prevent
commercialization of our products. If we or our suppliers fail to meet our
needs, our business, financial condition and results of operations would suffer.

If any facility or equipment in the facility of our manufacturers is
damaged or destroyed, we may not be able to quickly or inexpensively replace it.
If there are any quality or supply problems with any components or materials
supplied to our manufacturers for our products, we may not be able to quickly
remedy them.

If we are unable to meet the supply needs of our customers, our business,
financial condition and results of operations would be adversely affected.

IF WE ARE UNABLE TO OBTAIN FDA APPROVAL OF OUR MANUFACTURING SITE IN A
TIMELY MANNER, ANY RESULTING INTERRUPTION IN THE SUPPLY OF KERASTICK(R)
UNITS COULD HAVE AN ADVERSE EFFECT ON OUR REVENUE.

Our supply agreement with North Safety Products, Inc. terminated on
December 31, 2002. We have completed construction of our Kerastick(R)
manufacturing facility and are in the process of validating our methods and
preparing a submission to the FDA shortly for review. FDA approval is expected
in late 2003. If we encounter difficulties or delays in completing our
manufacturing facility, applying for approval, obtaining FDA approval of the
facility, or in manufacturing commercial quantities of the Kerastick(R), such
difficulties or delays would adversely affect our business, financial condition
or results of operations.

ANY FAILURE TO COMPLY WITH ONGOING GOVERNMENTAL REGULATIONS IN THE UNITED
STATES WILL LIMIT OUR ABILITY TO MARKET OUR FIRST PRODUCTS.

Our products are subject to continued and comprehensive regulation by the
FDA and by state and local regulations. These laws require, among other things,


32


- approval of manufacturing facilities, including adherence to "good
manufacturing and laboratory practices" during production and
storage,

- controlled research and testing of products even after approval, and

- control of marketing activities, including advertising and labeling.

Both the manufacture and marketing of our first products, the Levulan(R)
Kerastick(R) and the BLU-U(R) are subject to continuing FDA review. We and our
manufacturers must continue to comply with the FDA's current Good Manufacturing
Practices, commonly known as cGMP, and foreign regulatory requirements. The cGMP
requirements govern quality control and documentation policies and procedures.
In complying with cGMP and foreign regulatory requirements, we and our
third-party manufacturers will be obligated to expend time, money and effort in
production, record keeping and quality control to assure that our products meet
applicable specifications and other requirements. If we and our third-party
manufacturers fail to comply with these requirements, DUSA would be subject to
possible regulatory action and may be limited in the jurisdictions in which we
are permitted to sell our products.

As part of our approval from the FDA, we were required to conduct two
Phase IV follow-up studies. We have successfully completed the first study; the
second study, to evaluate the long-term recurrence rate of AKs after treatment
with our new therapy, began in 2002, and is scheduled for completion in 2003. If
we discover a previously unknown problem with the product, a manufacturer or its
facility, changes in product labeling restrictions or withdrawal of the product
from the market may occur. Manufacturing facilities are subject to ongoing
periodic inspection by the FDA, including unannounced inspections. We cannot
give any assurance that our third-party supply sources, or our own new
Kerastick(R) facility, if initially approved, will continue to meet all
applicable FDA regulations in the future. If we, or any of our manufacturers,
fail to maintain compliance with FDA regulatory requirements, it would be time
consuming and costly to remedy the problem(s) or to qualify other sources. These
consequences could have an adverse effect on our financial condition and
operations. If we fail to comply with applicable regulatory approval
requirements, a regulatory agency may:

- send us warning letters,

- impose fines and other civil penalties on us,

- suspend our regulatory approvals,

- refuse to approve pending applications or supplements to approved
applications filed by us,

- refuse to permit exports or our products from the United States,

- require us to recall products,

- require us to notify physicians of labeling changes and/or product
related problems,

- impose restrictions on our operations, or

- criminally prosecute us.


33


WE HAVE SIGNIFICANT LOSSES AND ANTICIPATE CONTINUED LOSSES FOR THE
FORESEEABLE FUTURE.

We have a history of operating losses. We expect to have continued losses
through at least 2003 as we continue research and development of new products
and attempt to increase sales in the marketplace. As of December 31, 2002, our
accumulated deficit was $44,082,927. We cannot predict whether any of our
products will achieve significant market acceptance or generate sufficient
revenues to become profitable. Our commercial success will depend on whether:

- our products are more effective therapies than currently available
treatments,

- physicians receive sufficient reimbursement for our products, and

- we can, either together with partners or alone, successfully market
our products.

IF WE ARE UNABLE TO PROTECT OUR PROPRIETARY TECHNOLOGY, TRADE SECRETS OR
KNOW-HOW, WE MAY NOT BE ABLE TO OPERATE OUR BUSINESS PROFITABLY.

WE HAVE LIMITED PATENT PROTECTION AND IF WE ARE UNABLE TO PROTECT OUR
PROPRIETARY RIGHTS, COMPETITORS MIGHT BE ABLE TO DEVELOP SIMILAR PRODUCTS
TO COMPETE WITH OUR PRODUCTS AND TECHNOLOGY.

Our ability to compete successfully depends, in part, on our ability to
defend patents that have issued, obtain new patents, protect trade secrets and
operate without infringing the proprietary rights of others. We have no product
patent protection for the compound ALA itself, as our basic patents are for
methods of detecting and treating various diseased tissues using ALA or related
compounds called precursors, in combination with light. Even where we have
patent protection, there is no guarantee that we will be able to enforce our
patents. We own or exclusively license patents and patent applications related
to the following:

- unique physical forms of ALA,

- methods of using ALA and its unique physical forms in combination
with light, and

- compositions and apparatus for those methods.

Some of the indications we are developing may not be covered by the claims
in our existing patents. In addition, a number of third-parties are seeking
patents for additional uses of ALA. These additional uses, whether patented or
not, could limit the scope of our future operations because other ALA products
might become available which would not infringe our patents. These products
would compete with ours even though they are marketed for a different use.


34


We have limited patent protection outside the United States, which may
make it easier for third-parties to compete there. Our basic method of treatment
patents and applications have counter-parts in only four foreign countries. Even
with the issuance of additional patents, other parties are free to develop other
uses of ALA, including medical uses, and to market ALA for such uses, assuming
that they have obtained appropriate regulatory marketing approvals. Certain
forms of ALA are commercially available chemical products. ALA in the chemical
form has been commercially supplied for decades, and is not itself subject to
patent protection and there are reports of several third-parties conducting
clinical studies with ALA for the treatment of certain conditions in countries
outside the United States where PARTEQ does not have patent protection.
Additionally, enforcement of a given patent may not be practicable or an
economically viable alternative.

Our patent protection in the Netherlands may be diminished or lost
entirely. In early 2003, we received notice that Netherlands Patent No. 9021172,
which relates to the basic method of using ALA, is being opposed. Under Dutch
patent law, we are permitted to file a response to this opposition. We can at
this time give no assurance of the likelihood of success of this opposition or
any assurance that we will decide to spend the funds required to oppose the
opposition. The Netherlands is not a major pharmaceutical market so the loss of
this patent, if it were to occur, is unlikely to have significant impact on our
potential revenues.

Our patent protection in Australia may be diminished or lost entirely. In
2002, we received notice of a lawsuit filed in Australia by PhotoCure ASA
alleging that Australian Patent No. 624985, which is one of the patents licensed
by PARTEQ Research & Development Innovations (the technology transfer arm of
Queen's University at Kingston, Ontario) to us, relating to our 5-aminolevulinic
acid technology, is invalid. As a consequence of this action, Queen's University
has assigned the Australian patent to us so that we may participate directly in
this litigation. We have filed a response to the allegations of invalidity in
court and have also filed a counter suit alleging that PhotoCure's activities in
Australia infringe the patent. We can at this time give no assurance of the
likelihood of success of the action alleging invalidity or any assurance that we
will decide to spend the funds required to complete the litigation. Australia is
a significant pharmaceutical market for AK therapies, and loss of this patent
could adversely affect us in at least two ways. First, if we seek to enter the
Australia market, the lack of a patent would probably retard or diminish our
market share.


35


Second, even if we did not seek to market in Australia, third-parties might not
be interested in licensing the product in Australia without patent protection,
and this might limit our potential revenues from this market.

While we attempt to protect our proprietary information as trade secrets
through agreements with each employee, licensing partner, consultant,
university, pharmaceutical company and agent, we cannot guarantee that these
agreements will provide effective protection for our proprietary information. It
is possible that:

- these persons or entities might breach the agreements,

- we might not have adequate remedies for a breach, and/or

- our competitors will independently develop or otherwise discover our
trade secrets.

PATENT LITIGATION IS EXPENSIVE, AND WE MAY NOT BE ABLE TO AFFORD THE
COSTS.

The costs of litigation or any proceeding relating to our intellectual
property rights could be substantial even if resolved in our favor. Some of our
competitors have far greater resources than we do and may be better able to
afford the costs of complex patent litigation. For example, third-party
competitors may infringe one or more of our patents, and we could be required to
spend significant resources to enforce our patent rights. Also, if we were to
sue a third-party for infringement of one or more of our patents in the United
States, that third-party could challenge the validity of our patent(s). We
cannot guarantee that a third-party or parties will not claim, with or without
merit, that we have infringed their patent(s), or misappropriated their
proprietary material. Defending this type of legal action involves considerable
expense and could negatively affect our financial results.

If a third-party were to file a United States patent application, or be
issued a patent claiming technology also claimed by us in a pending United
States application(s), we may be required to participate in interference
proceedings in the United States Patent and Trademark Office to determine the
priority of invention. A third-party also could request the declaration of a
patent interference between one of our issued patents, and a third-party United
States patent application. Any interference proceedings likely would require
participation by us and/or PARTEQ, and could involve substantial legal fees.

WE HAVE ONLY ONE THERAPY THAT HAS RECEIVED REGULATORY APPROVAL AND WE CANNOT
PREDICT WHETHER WE WILL EVER DEVELOP OR COMMERCIALIZE ANY OTHER PRODUCTS.


36


EXCEPT FOR THE LEVULAN(R) KERASTICK(R) WITH THE BLU-U(R) FOR PDT TO TREAT
AKS, ALL OF OUR PRODUCTS ARE IN EARLY STAGES OF DEVELOPMENT AND MAY NEVER
RESULT IN ANY COMMERCIALLY SUCCESSFUL PRODUCTS.

Currently, we are developing a single drug compound for a number of
different medical conditions. To be profitable, we must successfully research,
develop, obtain regulatory approval for, manufacture, introduce, market and
distribute our products. All of our products, except for the Levulan(R)
Kerastick(R) with the BLU-U(R) for PDT to treat AKs, and our efforts to achieve
the broader AK indication, are at an early stage of development. We cannot
predict how long the development for these products will take or whether they
will be medically effective. We cannot be sure that a successful market will
ever develop for our drug technology. We do not know if any of our products will
ever be commercially successful.

WE MUST RECEIVE SEPARATE APPROVAL FOR EACH OF OUR POTENTIAL PRODUCTS
BEFORE WE CAN SELL THEM COMMERCIALLY IN THE UNITED STATES OR ABROAD.

All of our potential products will require the approval of the FDA before
they can be marketed in the United States. If we fail to obtain the required
approvals for these products our revenues will be limited. Before an NDA, which
is an application to the FDA seeking approval to market a new drug, can be filed
with the FDA, a product must undergo, among other things, extensive animal
testing and human clinical trials. The process of obtaining FDA approvals can be
lengthy, costly, and time-consuming. Following the acceptance of an NDA, the
time required for regulatory approval can vary and is usually 1 to 3 years or
more. The FDA may require additional animal studies and/or human clinical trials
before granting approval. Our Levulan(R) PDT products are based on new
technology. To the best of our knowledge, the FDA has approved only 3 drugs for
use in photodynamic therapy, including Levulan(R). This factor may lengthen the
approval process. We face much trial and error and we may fail at numerous
stages along the way.

We cannot predict whether we will obtain approval for any of our potential
products. Data obtained from preclinical testing and clinical trials can be
susceptible to varying interpretations which could delay, limit or prevent
regulatory approvals. Future clinical trials may not show that Levulan(R) PDT or
PD is safe and effective for any new use we are studying. In addition, delays or
disapprovals may be encountered based upon additional governmental regulation
resulting from future legislation or administrative action or changes in FDA
policy. We must also obtain foreign regulatory clearances before we can market
any potential products in foreign markets. The foreign regulatory approval
process includes all of the risks associated with obtaining FDA marketing
approval and may impose substantial additional costs.


37


OUR LACK OF SALES AND MARKETING EXPERIENCE COULD AFFECT OUR ABILITY TO
MARKET OUR NON-DERMATOLOGY PRODUCTS, WHICH COULD ADVERSELY AFFECT OUR
REVENUES FROM FUTURE PRODUCT SALES.

Currently, we have no experience in developing, training or managing a
sales force. We will incur substantial additional expenses if we have to
undertake these business activities, and the costs of establishing a sales force
may exceed our product revenues. In addition, companies that may compete with us
currently have extensive and well-funded marketing and sales operations. Any
marketing and sales efforts, such as regional test marketing strategies, that we
undertake may be unsuccessful.

IF WE ARE UNABLE TO OBTAIN THE NECESSARY CAPITAL TO FUND OUR OPERATIONS,
WE WILL HAVE TO DELAY OUR DEVELOPMENT PROGRAMS AND MAY NOT BE ABLE TO
COMPLETE OUR CLINICAL TRIALS.

Since our sales goals for our first product have not been met, and may not
be met in the future, we may need substantial additional funds to fully develop,
manufacture, market and sell our other potential products. We cannot predict
exactly if, or when, additional funds will be needed. We may obtain funds
through a public or private financing, including equity financing, and/or
through collaborative arrangements. We cannot predict whether any financing will
be available on acceptable terms.

If funding is insufficient, we will have to continue to delay, reduce in
scope or eliminate some or all of our research and development programs as we
are doing in 2003. We may license rights to third parties to commercialize
products or technologies that we would otherwise have attempted to develop and
commercialize on our own.

BECAUSE OF THE NATURE OF OUR BUSINESS, THE LOSS OF KEY MEMBERS OF OUR MANAGEMENT
TEAM COULD DELAY ACHIEVEMENT OF OUR GOALS.

IF ANY OF THE KEY MEMBERS OF OUR MANAGEMENT WERE TO END THEIR RELATIONSHIP
WITH US, WE COULD EXPERIENCE SIGNIFICANT DELAYS IN OUR BUSINESS AND
RESEARCH OBJECTIVES.

We are a small company with only 43 employees. We are highly dependent on
several key officer/employees with specialized scientific and technical skills.
Our growth and future success will depend, in large part, on the continued
contributions of these key individuals as well as our ability to motivate and
retain these qualified personnel in our specialty drug and light device areas.
The


38


photodynamic therapy industry is still quite small and the number of experts is
limited. The loss of these key employees could cause significant delays in
achievement of our business and research goals since very few people with their
expertise could be hired. Our business, financial condition and results of
operations could suffer.

RISKS RELATED TO OUR INDUSTRY

PRODUCT LIABILITY AND OTHER CLAIMS AGAINST US MAY REDUCE DEMAND FOR OUR PRODUCTS
OR RESULT IN DAMAGES.

IF WE BECOME SUBJECT TO A PRODUCT LIABILITY CLAIM WE MAY NOT HAVE ADEQUATE
INSURANCE COVERAGE AND THE CLAIM COULD ADVERSELY AFFECT OUR BUSINESS.

The development, manufacture and sale of medical products exposes us to
the risk of significant damages from product liability claims. Although we
currently maintain product liability insurance for coverage of our products in
amounts we believe to be commercially reasonable we cannot be certain that the
coverage amounts are adequate or that continued coverage will be available at
acceptable costs. If the cost is too high, we will have to self-insure. A
successful claim in excess of our insurance coverage could have a material
adverse effect on our business, financial condition and results of operations.

OUR BUSINESS INVOLVES ENVIRONMENTAL RISKS AND WE MAY INCUR SIGNIFICANT
COSTS COMPLYING WITH ENVIRONMENTAL LAWS AND REGULATIONS.

We have used various hazardous materials, such as mercury in fluorescent
tubes in our research and development activities. Even though we do not
currently manufacture any products, we are subject to federal, state and local
laws and regulations which govern the use, manufacture, storage, handling and
disposal of hazardous materials and specific waste products. Now that we are
establishing our own production line for the manufacture of the Kerastick(R), we
are subject to additional environmental laws and regulations. During the design,
construction and validation phases of our new Kerastick(R) facility, we have
taken steps to ensure that appropriate environmental controls associated with
the facility comply with environmental laws and standards. We believe that we
are in compliance in all material respects with currently applicable
environmental laws and regulations. However, we cannot guarantee that we will
not incur significant costs to comply with environmental laws and regulations in
the future. We also cannot guarantee that current or future environmental laws
or regulations will not materially adversely affect our operations, business or
assets. In addition, although we believe our safety procedures for handling and
disposing of these


39


materials comply with federal, state and local laws and regulations, we cannot
completely eliminate the risk of accidental contamination or injury from these
materials. In the event of such an accident, we could be held liable for any
resulting damages, and this liability could exceed our resources.

WE MAY NOT BE ABLE TO KEEP UP WITH RAPID CHANGES IN THE BIOTECHNOLOGY AND
PHARMACEUTICAL INDUSTRIES THAT COULD MAKE SOME OR ALL OF OUR PRODUCTS
NON-COMPETITIVE OR OBSOLETE.

COMPETING PRODUCTS AND TECHNOLOGIES MAY MAKE SOME OR ALL OF OUR PROGRAMS
OR POTENTIAL PRODUCTS NONCOMPETITIVE OR OBSOLETE.

Our industry is subject to rapid, unpredictable and significant
technological change. Competition is intense. Well-known pharmaceutical,
biotechnology and chemical companies are marketing well-established therapies
for the treatment of various dermatological conditions including AKs. Doctors
may prefer familiar methods that they are comfortable using rather than try our
products. Many companies are also seeking to develop new products and
technologies for medical conditions for which we are developing treatments. Our
competitors may succeed in developing products that are safer or more effective
than ours and in obtaining regulatory marketing approval of future products
before we do. We anticipate that we will face increased competition as new
companies enter our markets and as the scientific development of PDT/PD
advances.

We expect that our principal methods of competition with other PDT
companies will be based upon such factors as:

- the ease of administration of our photodynamic therapy,

- the degree of generalized skin sensitivity to light,

- the number of required doses,

- the selectivity of our drug for the target lesion or tissue of
interest, and

- the type and cost of our light systems.

We cannot give any assurance that new drugs or future developments in PDT
or in other drug technologies will not have a material adverse effect on our
business. Increased competition could result in:

- price reductions,

- lower levels of third-party reimbursements,

- failure to achieve market acceptance, and

- loss of market share,


40


any of which could have an adverse effect on our business. Further, we cannot
give any assurance that developments by our competitors or future competitors
will not render our technology obsolete.

OUR COMPETITORS IN THE BIOTECHNOLOGY AND PHARMACEUTICAL INDUSTRIES MAY
HAVE BETTER PRODUCTS, MANUFACTURING CAPABILITIES OR MARKETING EXPERTISE.

Several companies are developing PDT agents other than Levulan(R). These
include: QLT PhotoTherapeutics Inc. (Canada); Axcan Pharma Inc. (U.S.);
Miravant, Inc. (U.S.); and Pharmacyclics, Inc. (U.S.). We are also aware of
several companies conducting research with ALA or ALA-related compounds,
including: medac GmbH and Photonamic GmbH & Co. KG (Germany); and PhotoCure ASA
(Norway) which entered into a marketing agreement with Galderma S.A. for
countries outside of Nordic countries for certain dermatology indications.

Many of our competitors have substantially greater financial, technical
and marketing resources than we have. In addition, several of these companies
have significantly greater experience than we do in developing products,
conducting preclinical and clinical testing and obtaining regulatory approvals
to market products for health care.

PhotoCure has received marketing approval of its ALA precursor (ALA
methyl-ester) compound with PDT for the treatment of AKs in the European Union,
New Zealand, and countries in Scandinavia. PhotoCure has also filed for
regulatory approvals in Australia and the United States. In the United States,
PhotoCure has received a notice of approvability from the FDA. Upon PhotoCure
receiving approval from the FDA to market its product in the United States, its
entry into the marketplace will likely represent direct competition for our
products. See section entitled "Business - Legal Proceedings".

Axcan Pharma Inc. has announced that it has received preliminary approval
from the FDA for the use of its product, PHOTOFRIN(R), for photodynamic therapy
in the treatment of high grade dysplasia associated with Barrett's esophagus.
Axcan reported that it expects a final approval of its new drug application
within the next few months. The approval would allow Axcan to be the first to
market a PDT therapy for this indication, which we are also pursuing.


41


RISKS RELATED TO OUR STOCK

IF THE STOCK PRICE RISES, AND IF OUTSTANDING OPTIONS AND WARRANTS ARE CONVERTED,
THE VALUE OF THOSE SHARES OF COMMON STOCK OUTSTANDING JUST PRIOR TO THE
CONVERSION WILL BE DILUTED.

As of February 15, 2003 there were outstanding options and warrants to
purchase 2,540,774 shares of common stock, with exercise prices ranging from
U.S. $2.90 to $31.00 per share, respectively, and ranging from CDN $4.69 to CDN
$10.875 per share, respectively. Currently, the market price of the common stock
is lower than all options and warrants, so their exercise is unlikely at this
time. However, if the stock price rises and if the holders exercise a
significant number of these securities at any one time, the market price of the
common stock could fall. The value of the common stock held by other
shareholders will be diluted. The holders of the options and warrants have the
opportunity to profit if the market price for the common stock exceeds the
exercise price of their respective securities, without assuming the risk of
ownership. If the market price of the common stock does not rise above the
exercise price of these securities, then they will expire without exercise. The
holders are likely to exercise their securities when we would probably be able
to raise capital from the public on terms more favorable than those provided in
these securities.

RESULTS OF OUR OPERATIONS AND GENERAL MARKET CONDITIONS FOR BIOTECHNOLOGY STOCK
COULD RESULT IN THE SUDDEN CHANGE IN THE MARKET VALUE OF OUR STOCK.

The price of our common stock has been highly volatile. These fluctuations
create a greater risk of capital losses for our shareholders as compared to less
volatile stocks. From January 1, 2002 to February 15, 2003, our stock price has
ranged from a high of $7.83 to a low of $1.32. Factors that contributed to the
volatility of our stock during the last 12 months included:

- disappointing product sales,

- termination of our Schering AG agreement,

- general market conditions,

- timing and amounts of third-party payor reimbursement for our
therapy, and

- clinical trial results.

The significant general market volatility in similar stage pharmaceutical
and biotechnology companies made the market price of our common stock even more
volatile.

IF OUR MARKET CAPITALIZATION REMAINS AT A LEVEL SIGNIFICANTLY BELOW OUR CASH
VALUE, WE COULD BE SUBJECT TO A TENDER OFFER THAT DOES NOT REFLECT THE POTENTIAL
VALUE OF OUR BUSINESS AND COULD MINIMIZE THE RETURN TO OUR SHAREHOLDERS OF THEIR
INVESTMENTS.


42


The price of our common stock has been negatively impacted by
disappointing product sales, the termination of our Schering AG agreement,
general market conditions, and the limited acceptance of the value of our
therapy. Based on this, our share price traded at a level below our cash value
during much of 2002. Until such time that we demonstrate the potential value of
our therapy in the marketplace and our share price is more reflective of such
potential value, there is an increased risk of companies offering to acquire us
at reduced values which do not reflect the business potential of our assets.

EFFECTING A CHANGE OF CONTROL OF DUSA WOULD BE DIFFICULT, WHICH MAY DISCOURAGE
OFFERS FOR SHARES OF OUR COMMON STOCK.

Our certificate of incorporation authorizes the board of directors to
issue up to 100,000,000 shares of stock, 40,000,000 of which are common stock.
The board of directors has the authority to determine the price, rights,
preferences and privileges, including voting rights, of the remaining 60,000,000
shares without any further vote or action by the shareholders. The rights of the
holders of our common stock will be subject to, and may be adversely affected
by, the rights of the holders of any preferred stock that may be issued in the
future.

On September 27, 2002, the Company adopted a shareholder rights plan (the
"Rights Plan") at a special meeting of the Board of Directors. The Rights Plan
provides for the distribution of one right as a dividend for each outstanding
share of common stock of the Company to holders of record as of October 10,
2002. Each right entitles the registered holder to purchase one one-thousandths
of a share of preferred stock at an exercise price of $37.00 per right. The
rights will be exercisable subsequent to the date that a person or group either
has acquired, obtained the right to acquire, or commences or discloses an
intention to commence a tender offer to acquire, 15% or more of the Company's
outstanding common stock (or 20% of the outstanding common stock in the case of
a shareholder or group who beneficially held in excess of 15% at the record
date), or if a person or group is declared an Adverse Person, as such term is
defined in the Rights Plan. The rights may be redeemed by the Company at a
redemption price of one one-hundredth of a cent per right until ten days
following the date the person or group acquires, or discloses an intention to
acquire, 15% or 20% or more, as the case may be, of the Company, or until such
later date as may be determined by the Board.

Under the Rights Plan, if a person or group acquires the threshold amount
of common stock, all holders of rights (other than the acquiring shareholder)
may, upon payment of the purchase price then in effect, purchase shares of
common stock having a value of twice the purchase price. In the event that the
Company is involved in a merger or other similar transaction where it is not the
surviving corporation, all holders of rights (other than the acquiring
shareholder) shall be entitled, upon payment of the purchase price then in
effect, to purchase common stock of the surviving corporation having a value of
twice the purchase price. The rights will expire on October 10, 2012, unless
previously redeemed. The Board has adopted certain amendments to the Company's
Certificate of Incorporation consistent with the terms of the Rights Plan. The
Rights Plan could discourage, delay or prevent a person or group from acquiring
15% or more (or 20% or more in the case of certain parties) of our common stock,
thereby limiting, perhaps, the ability of our shareholders to benefit from such
a transaction.

ITEM 2. PROPERTIES

In May 1999 we entered into a five year lease for 16,000 sq. ft. of
office/warehouse space to be used for offices and manufacturing in Wilmington,
Massachusetts. On February 1, 2001, we entered into a five year lease for an
additional 24,000 square feet of space at our Wilmington facility. As part of
our planned build-out of the facility, in December 2001 we replaced the two 5
year leases with a new 15 year lease covering the entire building through
November 2016. We have the ability to terminate the Wilmington lease after the
10th year (2011) of the lease by providing the landlord with notice at least 7
and one-half months prior to the date on which the termination


43


would be effective. In October 2002, we entered into a five year lease
commitment for approximately 2,000 square feet, for our wholly-owned subsidiary,
DUSA Pharmaceuticals New York, Inc., replacing the space DUSA previously
occupied. Commencing in August 2002, we entered into a five year lease for
different office space for our Toronto location, at approximately half the cost
of our previous office space. This facility accommodates the Toronto office of
our President and shareholder services representative. See "Note 14(b) to the
Company's Notes to the Consolidated Financial Statements".

ITEM 3. LEGAL PROCEEDINGS

In April 2002, we received a copy of a notice issued by PhotoCure ASA to
Queen's University at Kingston, Ontario, alleging that Australian Patent No.
624985 is invalid. Australian Patent No. 624985 is one of the patents covered by
our agreement with PARTEQ Research & Development Innovations, the technology
transfer arm of Queen's University, relating to 5-aminolevulinic acid
technology. PhotoCure instituted this proceeding on April 12, 2002 in the
Federal Court of Australia, Victoria District Registry. As a consequence of this
action, Queen's University has assigned the Australian patent to us so that we
may participate directly in this litigation. We filed an answer setting forth
our defenses and a related countersuit alleging that PhotoCure's activities
infringe the patent. The case is in its earliest stages so we are unable to
predict the outcome at this time, but our intention is to vigorously defend our
intellectual property. See section entitled "Business - Patents and Trademarks;
and - Competition". For other patent matters, see section entitled "Risk Factors
- - If we are unable to protect our proprietary technology, trade secrets or
Know-how, we may not be able to operate our business profitably."

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.


44


PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock is traded on the NASDAQ National Market under the symbol
"DUSA." The following are the high and low closing prices for the common stock
reported for the quarterly periods shown.

Price range per common share by quarter, 2001:



First Second Third Fourth
----- ------ ----- ------

NASDAQ
High $18.938 $17.500 $14.140 $11.150
Low 10.438 11.125 8.730 7.290


Price range per common share by quarter, 2002:



First Second Third Fourth
----- ------ ----- ------

NASDAQ
High $7.830 $4.550 $2.690 $1.890
Low 3.790 1.840 1.400 1.320


On March 5, 2003, the closing price of our common stock was $1.569 per
share on the NASDAQ National Market. On March 5, 2003, there were approximately
664 holders of record of our common stock.

We have never paid cash dividends on our common stock and have no present
plans to do so in the foreseeable future.


45


ITEM 6. SELECTED FINANCIAL DATA

The following information is qualified by reference to and should be read
in conjunction with the Company's Consolidated Financial Statements and the
Notes thereto and Management's Discussion and Analysis of Financial Condition
and Results of Operations included elsewhere in this report. The selected
financial data for the Company set forth below as of and for the years ended
December 31, 2002, 2001, 2000, 1999 and 1998 have been derived from the
Company's audited consolidated financial statements.

CONSOLIDATED STATEMENTS OF OPERATIONS DATA



Year ended December 31,
-------------------------------------------------------------------------------------
2002 (1) 2001 2000 1999 1998
----------- ------------ ------------ ------------ -----------

Revenues (1) $25,483,238 $ 5,390,736 $ 2,120,557 $ -- $ --

Cost of product sales and royalties (1) 5,253,424 2,148,994 1,104,664 -- --

Research and development costs (1) 12,121,606 10,789,906 8,163,419 4,194,532 4,502,391

General and administrative costs 5,591,039 3,654,792 2,615,502 1,818,193 1,729,741

Income (loss) from operations 2,517,169 (11,202,956) (9,763,028) (6,012,725) (6,232,132)

Other income, net 3,245,349 3,844,860 3,222,273 574,098 515,184

Income tax expense -- -- -- 90,000 --

Net income (loss) 5,762,518 (7,358,096) (6,540,755) (5,528,627) (5,716,948)

Basic and diluted net income (loss) per
common share $ 0.42 $ (0.53) $ (0.49) $ (0.50) $ (0.61)

Weighted average number of shares 13,877,566 13,791,735 13,285,472 11,061,016 9,365,950
outstanding


CONSOLIDATED BALANCE SHEETS DATA



As of December 31,
--------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- ----------

Total assets $60,949,973 $75,864,221 $82,442,388 $28,156,845 $7,140,675

Cash and investment securities 52,879,543 64,709,625 74,496,577 26,897,580 6,722,132

Deferred revenue (1) 5,100 22,585,856 24,805,041 9,791,667 --

Long-term debt (2) 1,517,500 -- -- -- --

Shareholders' equity 56,057,730 49,834,537 55,309,796 17,059,928 6,416,146


(1) Includes the recognition in 2002 of approximately $20,990,000 in revenues,
$2,638,000 in cost of product sales and $639,000 in research and
development costs as a result of the termination of our former dermatology
collaboration arrangement. See section entitled "Management's Discussion
and Analysis - Overview, Termination of Dermatology


46


Collaboration Agreement". These amounts were previously deferred and were
being amortized into operations over 1 to 12.5 years.

(2) Excludes current portion of long-term debt.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

When you read this section of this report, it is important that you also
read the financial statements and related notes included elsewhere in this
report. This section contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those we
anticipate in these forward-looking statements for many reasons, including the
factors described below and in "Risk Factors."

OVERVIEW

DUSA is a pharmaceutical company engaged primarily in the research,
development, and marketing of a drug named 5-aminolevulinic acid, or ALA, used
in combination with appropriate light devices in order to detect or treat a
variety of medical conditions. The trademark for our brand of ALA is Levulan(R).
When Levulan(R) is used and followed with exposure to light to produce a
therapeutic effect, the technology is called photodynamic therapy, or PDT. When
Levulan(R) is used and followed with exposure to light to detect medical
conditions, the technology is called photodetection, or PD. Our first products,
which were launched in September 2000 in the United States, are Levulan(R) 20%
topical solution using our Kerastick(R) brand applicator, and our BLU-U(R) brand
light unit. Our products are used together to provide PDT for the treatment of
non-hyperkeratotic actinic keratoses, or AKs, of the face or scalp.

We have primarily devoted our resources to funding research and
development in order to advance the Levulan(R) PDT/PD technology platform, and
as a result, we have experienced significant operating losses. As of December
31, 2002, we had an accumulated deficit of approximately $44,083,000. Achieving
our goal of becoming a profitable operating company is dependent upon the market
penetration of our products, acceptance of our therapy by the medical and
consumer constituencies, and our ability to develop new products.

We have been encouraged by the positive response from many physicians and
patients who have used our therapy, but recognize that we have to demonstrate
the clinical value of our new and unique therapy, and the benefits compared to
other well-established conventional therapies, in order for the medical
community to accept our products on a large scale. We also recognize that market
acceptance has taken longer than we originally anticipated, and has not reached
the levels that were originally expected.


47

As of March 1, 2003, the national reimbursement code for Medicare and
other third-party payors for the BLU-U(R) application procedure, and for the
costs of the Levulan(R) Kerastick(R), became effective. Doctors can also bill
for any applicable visit fees. However, some physicians have suggested that even
the new reimbursement levels still do not fully reflect the required efforts to
routinely execute our therapy in their practices. In addition, others have
reported problems prior to March 1, 2003 of getting reimbursed at the level
indicated, or at all. These issues have affected the economic competitiveness of
our products with other AK therapies and hence have hindered the adoption of our
therapy in many cases. Accordingly, we are continuing to support efforts to
improve reimbursement levels to physicians, work with the major private
insurance carriers to reimburse our therapy, and to resolve related billing and
payment issues, which we believe could significantly improve physician adoption.
We are hopeful that the recent changes to reimbursement, plus future
improvements, along with our education and marketing programs, will help make
Levulan(R) PDT a common therapy for AKs over time.

We expect to continue to incur operating losses, despite this year's net
gain due to the financial reporting of the termination of our dermatology
collaboration agreement, until the successful market penetration of our first
products occurs. We are focusing our near-term dermatology research and
development efforts on the commencement of clinical trials which, if successful,
could lead to approval of a broader AK indication. As a result of the
termination of our former dermatology collaboration arrangement, we have
reevaluated our expenses and intend to minimize research and development and
related general and administrative expenditures that are not directly related to
our core objectives for 2003. During 2002, we decreased our staff to 43
full-time employees by year-end as compared to 55 at the end of the previous
year. We expect to slightly increase our staff in 2003 as we focus on marketing
activities and customer support associated with reacquiring the rights to our AK
products, and research and development programs for dermatology and internal
indications. While our financial position is strong, we cannot predict when
product sales along with interest and/or other income may offset the cost of
these efforts.

We have incurred scale-up and certain fixed costs resulting in
under-absorbed overhead, which are included in cost of product sales and
royalties. Once our manufacturing facility is operational, management plans to
continuously monitor the cost of product sales with the goal of reducing our
costs over time. We expect that the development of our own facility will enable
us to better manage and control the costs of production; however, our unit cost
per Kerastick(R) is expected to be higher initially, until product sales
increase significantly. Construction started in January 2002, and was completed
during 2002. Facility qualification, process validation, drug product stability
testing, and FDA review and approval are expected to be completed during 2003.
This new facility replaces our former third-party Kerastick(R) manufacturer.

For non-dermatology indications, such as treatment of dysplasia in
patients with Barrett's esophagus, we may enter into joint development or
licensing arrangements, both domestically and internationally, with
pharmaceutical or medical device companies, as we did with Photonamic for
fluorescent-guided resection of brain cancer. However, at this point in time, we
have decided not to seek a new dermatology collaboration. To the extent that we
do not enter into such arrangements, we


48


may require separate funding to complete the regulatory approval process for our
non-dermatology products and would likely need additional funds to market such
products.

TERMINATION OF DERMATOLOGY COLLABORATION AGREEMENT - On September 1, 2002,
DUSA and Schering AG, our former marketing and development partner for
Levulan(R) PDT in the field of dermatology, terminated our marketing,
development and supply agreement, dated November 22, 1999, as amended. As a
result, we reacquired all of the rights we granted to Schering AG under the
agreement. Co-development revenue from Schering AG was earned as we performed
research, and deferred revenue relating to previously received milestone
payments was being amortized into income over the 12 1/2 year life of our
terminated agreement. Due to the termination of the agreement, unamortized
deferred revenue and related deferred charges were recognized in the
Consolidated Statement of Operations for the year ended December 31, 2002,
resulting in a net profit for 2002 rather than a net loss had the agreement
remained effective.

Schering AG agreed to continue its financial support for the dermatology
research and development program for the remainder of 2002, including payments
totaling $2,050,000 by December 31, 2002, and to complete several ongoing
clinical studies for our benefit. No further payments are due to us from
Schering AG. Schering AG will transfer all of its interest in the regulatory
filings it made in Brazil. However, as we have determined that we should
concentrate solely on the US market at this time, we authorized Schering AG to
withdraw the applications for regulatory approval of Levulan(R) PDT in Austria,
Australia, and South Africa. The regulatory approvals for Canada (held by Draxis
Health, Inc.) and Brazil will be maintained.

Due to the termination of our former dermatology collaboration
arrangement, we evaluated certain items on our Consolidated Balance Sheet for
the timing of revenue recognition and potential impairment. These items included
unamortized deferred revenue related to non-refundable milestone payments
previously received under the Schering AG agreement, and approximately
$6,950,000 in assets, including our nearly completed manufacturing facility, raw
material and finished goods inventories, commercial light units in the field,
and deferred charges and royalties. As a result of this analysis, in addition to
normal amortization recorded prior to the termination of the agreement, we
recorded the following items in our financial statements for the year ended
December 31, 2002:


49




REVENUE FINANCIAL
RECOGNITION/ STATEMENT
ASSET FOOTNOTE
STATEMENT OF OPERATIONS ITEM BALANCE SHEET ITEM IMPAIRMENT REFERENCE
---------------------------- ------------------ ------------ ---------

Revenues:

Research grant and milestone revenue Deferred revenue $20,990,274 Note 10
-----------

Operating Costs:

Cost of product sales Deferred charges 542,766 Note 7

Inventory 1,705,364 Note 5

BLU-U(R) units under lease
or rental 389,647 Note 6

Research and development costs Deferred royalty 639,051 Note 7
----------
$3,276,828
----------
Total Charges to Operating Costs


We concluded that the carrying value of our nearly completed manufacturing
facility is more likely than not to be fully recoverable after considering the
effects of the change in business circumstances caused by the termination of our
former dermatology collaboration arrangement. Therefore, no impairment charges
associated with the facility were recorded in 2002; however, we will continue to
periodically review the carrying value of the facility.

Following the reacquisition of rights from our former partner, we
commenced our own marketing, education, and development strategy. We will
continue to develop and implement such strategies directly and will incur
significant expenses relating to these activities. On September 1, 2002, we
entered into an exclusive distribution agreement with Moore Medical Corporation
to distribute the Kerastick(R) throughout the United States. See section
entitled "Management's Discussion and Analysis - Overview, Third-party
Distribution Agreement." For now, we have decided not to create a nationwide
sales force, or to seek a new dermatology marketing partner. Should we decide to
hire a sales force, we will incur significant expenses relating to these
activities. Initially, we intend to focus on establishing a clear position for
our therapy in the marketplace, meeting the needs of dermatologists, and
educating them about the benefits of our therapy, in an effort to increase
product sales over time. This will be accomplished through the support of
medical education activities, participation in dermatology conferences, support
of Company-sponsored


50


research and development efforts and independent investigator studies, and
support of efforts to improve third party reimbursement. We intend to carry out
some limited regional test marketing strategies during 2003, and depending on
the response, we may consider building a sales force in the future. We are also
planning clinical studies, which if successful, could support a broader AK
indication. We are also offering a new BLU-U(R) placement program for
physicians, rather than the former rental and long-term lease arrangements, and
have introduced a Kerastick(R) sampling program to allow new doctors to become
familiar with the therapy.

THIRD PARTY DISTRIBUTION AGREEMENT - Effective September 1, 2002, we
engaged Moore Medical Corporation, a national distributor and marketer of
medical and surgical supplies, to be our exclusive distributor of the
Kerastick(R) in the United States. The agreement has a 1 year term, which can
be automatically renewed for additional 1 year terms, unless either party
notifies the other party prior to a term expiration that it does not intend to
renew the agreement. In addition, either party may terminate the agreement
earlier, on certain terms, or in the event that the other party shall have
materially breached any of its obligations in the agreement. Moore has a right
to return its inventory of Kerastick(R) units for full credit for a period of
time prior to and after the expiration date of the agreement. Accordingly, we
recognize product sales when Moore sells the Kerastick(R) to the end-user as the
price is fixed and final to Moore at that point.

THIRD-PARTY KERASTICK(R) MANUFACTURER AGREEMENT MODIFICATION - In early
2001, we agreed to compensate North Safety Products, Inc. ("North"), the
manufacturer of our Kerastick(R) brand applicator, for certain overhead expenses
associated with the manufacture of the Kerastick(R) to cover underutilization of
North's facilities, in accordance with an amendment to the purchase and supply
agreement, since our order levels were below certain previously anticipated
levels. We reported the total commitment of $1,400,000 in deferred charges, and
recognized this amount in cost of product sales and royalties from July 2001
through December 2002. In consideration for the underutilization fees, North
agreed to maintain its Kerastick(R) manufacturing capabilities in a state of
readiness through December 31, 2002. North manufactured and delivered
approximately 45,000 Kerastick(R) units to us during the fourth quarter of 2002.
In September 2001, in accordance with an amendment to our former agreement with
Schering AG, Schering AG reimbursed $1,000,000 of the costs we incurred to
modify our manufacturing agreement with North. This amount was reported in
deferred liabilities and was recognized as an offset to cost of product sales
and royalties on a straight-line basis over the term of the agreement with North
through December 2002.

In early 2001, in order to meet the production scheduling needs of our
third-party manufacturer of the BLU-U(R), National Biological Corporation
("NBC"), we prepaid raw material costs in the amount of $400,000 associated with
our orders. This amount was credited against the final purchase price of
finished units, which was due on delivery at the rate of $1,000 per completed
unit. At the end of December 2001, approximately $42,000 of this prepayment
remained outstanding and was recorded in other current assets. During 2002, the
balance of this credit was applied to other invoices and no amount remained
outstanding at December 31, 2002. The agreement has a term of


51


10 years which expires in 2008, subject to earlier termination for breach or
insolvency or for convenience on 12 months prior written notice.

SHAREHOLDER RIGHTS PLAN - In order to protect the long term interest of
our shareholders, we adopted a Shareholder Rights Plan, on September 27, 2002.
See "Note 10 to the Notes to the Consolidated Financial Statements - Shareholder
Rights Plan." The Shareholder Rights Plan is designed to prevent an acquirer
from gaining control of the company without offering a fair price to all of our
shareholders. The Shareholder Rights Plan was not adopted by the Board in
response to any specific offer or threat, but rather is intended to protect the
interests of shareholders in the event we are confronted in the future with an
unfriendly takeover attempt. Issuance of shares of common stock under the
Shareholder Rights Plan could be used to make a change in control of our company
more difficult or costly by diluting stock ownership of persons seeking to
obtain control of us. In addition, the Board of Directors adopted certain
amendments to our Certificate of Incorporation which are consistent with the
terms of the Plan.

LICENSE AND SUPPLY AGREEMENTS - On December 30, 2002, we entered into a
license and development agreement with Photonamic GmbH & Co. KG, a subsidiary of
medac GmbH, a German pharmaceutical company, and a supply agreement for the
licensed formulation with medac. These agreements provide for the licensing to
us of Photonamic's proprietary technology related to ALA for systemic dosing in
the field of brain cancer. The technology provides us with access to a systemic
formulation of ALA, and a significant amount of pre-clinical data, both of which
could also be useful and are licensed to us for certain other indications.
Photonamic is currently conducting a European Phase III clinical trial in which
ALA-induced fluorescence is used to guide surgical tumor resection in patients
suffering from the most aggressive form of adult brain tumor, glioblastoma
multiforme. This clinical trial is expected to continue through late 2004, at a
minimum. Our license covers both this primary clinical indication as well as
other brain cancers. Based on the license agreement, DUSA paid Photonamic a
non-refundable $500,000 milestone payment in early 2003. This amount was charged
to research and development costs in the Consolidated Statement of Operations in
the year ended December 31, 2002.

We will also be obligated to pay certain regulatory milestones and
royalties on net sales of a brain cancer product under the terms of the license
and development agreement and will purchase product under the supply agreement
for mutually agreed upon indications. Should Photonamic's clinical study be
successful, we will be obligated to proceed with development of the product in
the United States in order to retain the license for the use of the technology
to treat brain cancer. We are unable to determine at this time whether these
obligations will mature.

AUSTRALIAN PATENT LITIGATION - In April 2002, we received a copy of a
notice issued by PhotoCure ASA to Queen's University at Kingston, Ontario,
alleging that Australian Patent No. 624985, which is one of the patents licensed
by PARTEQ to us, relating to 5-aminolevulinic acid technology, is invalid. As a
consequence of this action, Queen's University has assigned the Australian
patent to us so that we may participate directly in this litigation. We have
filed an answer setting forth our defenses and a related countersuit alleging
that PhotoCure's activities infringe the patent. The case is in its earliest
stages so we are unable to predict the outcome at this time.


52


CRITICAL ACCOUNTING POLICIES

In May 2002, the United States Securities and Exchange Commission ("SEC")
issued disclosure guidance and proposed rules for "critical accounting policies"
entitled "Disclosure in Management's Discussion and Analysis about the
Application of Critical Accounting Policies." The SEC defines "critical
accounting policies" as those that require application of management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain and may
change in subsequent periods and that can significantly affect our financial
position and results of operations. Our accounting policies are disclosed in
Note 2 to the Notes to the Consolidated Financial Statements. Since all of these
accounting policies do not require management to make difficult, subjective or
complex judgments or estimates, they are not all considered critical accounting
policies. We have discussed these policies and the underlying estimates used in
applying these accounting policies with our audit committee. We consider the
following policies and estimates to be critical to our financial statements.

REVENUE RECOGNITION - Revenues on product sales of the Kerastick(R) are
recognized when persuasive evidence of an arrangement exists, the price is fixed
and final, delivery has occurred, and there is reasonableness of collection.
Research revenue earned under collaborative agreements consisted of
non-refundable research and development funding from our former dermatology
collaboration partner. Research revenue generally compensates us for a portion
of agreed-upon research and development expenses and is recognized as revenue at
the time the research and development activities are performed under the terms
of the related agreements and when no future performance obligations exist.
Milestone or other up-front payments have been recorded as deferred revenue upon
receipt and are recognized as income on a straight-line basis over the term of
our agreement with our former collaborator. Although we make every effort to
assure the reasonableness of our estimates, significant unanticipated changes in
our estimates due to business, economic, or industry events could have a
material impact on our results of operations. As a consequence of the
termination of DUSA's former dermatology collaboration arrangement, we recorded
$20,990,000 of previously received research grant and milestone revenue, in
addition to normal amortization recorded prior to the termination, in our
Consolidated Statements of Operations for the year ended December 31, 2002,
resulting in a net profit for the year despite minimal product sales. See
section entitled "Management's Discussion and Analysis - Overview, Termination
of Dermatology Collaboration Agreement."

INVENTORY - Inventories are stated at the lower of cost or market. Cost is
determined using the first-in, first-out method. Inventories are continually
reviewed for slow moving, obsolete and excess items. Inventory items identified
as slow-moving are evaluated to determine if an adjustment is required.
Additionally, our industry is characterized by regular technological
developments that could result in obsolete inventory. Although we make every
effort to assure the reasonableness of our estimates, any significant
unanticipated changes in demand, technological development, or significant
changes to our business model could have a significant impact on the value of
our inventory and our results of operations. In September 2002, based on the
termination of our former dermatology collaboration arrangement, we recorded
lower of cost or market adjustments of $2,095,000 for excess inventory and
commercial light units under lease, rental, or trial arrangements


53

to cost of product sales in our Consolidated Statements of Operations for the
year ended December 31, 2002. We used sales projections to estimate the
appropriate level of inventory that should remain on the Consolidated Balance
Sheet. Management believes that the level of remaining inventory is reasonable
in light of our current sales forecasts and uncertainties relating to the timing
of FDA approval of our manufacturing facility. Should we be unable to achieve
the forecasted sales, additional adjustments may be recorded to cost of goods
sold. See section entitled "Management's Discussion and Analysis - Overview,
Termination of Dermatology Collaboration Agreement."

VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS - We review long-lived and
intangible assets, comprised of property, plant and equipment, deferred charges,
and deferred royalties for impairment whenever events or changes in business
circumstances indicate that the carrying amount of assets may not be fully
recoverable or that the useful lives of these assets are no longer appropriate.
Factors considered important which could trigger an impairment review include
significant changes relative to: (i) projected future operating results; (ii)
the use of the assets or the strategy for the overall business; (iii) business
collaborations; and (iv) industry, business, or economic trends and
developments. Each impairment test is based on a comparison of the undiscounted
cash flow to the recorded value of the asset. When it is determined that the
carrying value of long-lived or intangible assets may not be recoverable based
upon the existence of one or more of the above indicators of impairment, the
asset is written down to its estimated fair value on a discounted cash flow
basis. In 2002, we concluded that the termination of our former dermatology
collaboration arrangement did not cause any impairment of our manufacturing
facility under construction, but did result in impairment charges to operations
of $1,182,000 related to adjustments of certain intangible assets as more fully
discussed in Note 3 to the Notes to the Consolidated Financial Statements. See
section entitled "Management's Discussion and Analysis - Overview, Termination
of Dermatology Collaboration Agreement." At December 31, 2002, our total
property, plant and equipment had a carrying value of $5,230,000, including
$2,596,000 associated with our manufacturing facility, and we had no intangible
assets recorded as of that date.

STOCK-BASED COMPENSATION - We have elected to continue to use the
intrinsic value-based method to account for employee stock option awards under
the provisions of Accounting Principles Board Opinion No. 25, and to provide
disclosures based on the fair value method in the Notes to the Consolidated
Financial Statements as permitted by Statement of Financial Accounting Standards
("SFAS") No. 123. Stock or other equity-based compensation for non-employees is
accounted for under the fair value-based method as required by SFAS No. 123 and
Emerging Issues Task Force ("EITF") No. 96-18, "Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services" and other related interpretations.
Under this method, the equity-based instrument is valued at either the fair
value of the consideration received or the equity instrument issued on the date
of grant. The resulting compensation cost is recognized and charged to
operations over the service period, which, in the case of stock options, is
generally the vesting period. As we utilize stock and stock options as one means
of compensating employees, consultants, and others, the accounting for
stock-based compensation could, under certain circumstances, result in a
material effect on our results of operations, but would not affect cash flow
based on our current stock option plan.

RESULTS OF OPERATIONS - YEAR ENDING DECEMBER 31, 2002 AS COMPARED TO 2001


54


REVENUES - Total revenues for the year ended December 31, 2002 were
$25,483,000, as compared to $5,391,000 in 2001. Research grant and milestone
revenues were $22,312,000 in 2002, as compared to $1,983,000, and included the
one-time recognition in September 2002 of unamortized up-front milestone and
unrestricted grant payments previously received from Schering AG totaling
$20,990,000 due to the finalization of this relationship in September 2002, and
normal amortization of $1,322,000 received prior to the termination. In 2001,
research grant and milestone revenue included normal amortization of $1,983,000.
See section entitled "Management's Discussion and Analysis - Overview,
Termination of Dermatology Collaboration Agreement." Revenues for 2002 also
included $2,851,000 of research and development reimbursement which we earned
from our former marketing partner, as compared to $2,893,000 in 2001. Due to the
termination of this agreement, we will not receive any co-development revenue
from Schering AG subsequent to 2002.

Revenues for 2002 also included product sales and rental income of
$319,000, as compared to $515,000 in 2001, reflecting $209,000 of direct
Kerastick(R) sales from our distributor, Moore Medical Corporation, to
physicians. We believe that the decline in direct Kerastick(R) sales in 2002 as
compared to 2001 is due mainly to the limited acceptance of our therapy,
reimbursement issues, and need for additional medical education for the optimum
use of our therapy. Also included in 2002 product sales and rental income were
royalty revenues of $77,000 which we earned for Kerastick(R) sales by Berlex,
the subsidiary of our former marketing partner, to its distributor. In 2002, we
had no direct Kerastick(R) sales to Berlex. In 2001, product sales and rental
income included direct Kerastick(R) sales of $358,000 to Berlex as Berlex
purchased Kerastick(R) units to fill the anticipated forecasts at the time the
units were ordered, royalty revenues of $55,000, rental income of $78,000, and
miscellaneous product sales of $24,000.

In September 2002, we initiated a new BLU-U(R) placement strategy as part
of our new marketing initiatives. Under this plan, physicians receive the
BLU-U(R) unit in exchange for an agreement to purchase a minimum of 24
Kerastick(R) units each year. Previous BLU-U(R) marketing programs, which
included leasing or renting the BLU-U(R) to physicians, medical institutions and
academic centers, have been terminated. As of December 31, 2002, excluding
BLU-U(R) units installed at clinical trial sites or sold to our former partner,
328 BLU-U(R) units were in place, up from the 282 units at December 31, 2001.
Kerastick(R) sales to end-users were 7,116 in 2002 as compared to 7,071 in 2001.
We believe that as doctors become more familiar with the benefits of Levulan(R)
PDT, if an FDA approval for a broader AK indication claim is achieved, and
improved reimbursement for physicians is attained, more widespread adoption of
our technology should occur over time.

COST OF PRODUCT SALES AND ROYALTIES - Cost of product sales and royalties
for the year ended December 31, 2002 were $5,253,000, as compared to $2,149,000
in 2001. The increase was mainly attributed to the recognition of $2,638,000 for
lower of cost or market inventory adjustments, increased depreciation taken on
BLU-U(R) units, and deferred charges associated with our amended Supply
Agreement with Sochinaz SA, which were based on (i) the termination of our
former dermatology collaboration arrangement, (ii) limited product sales since
the September 2000 product


55


launch, and (iii) our expectation of no significant near-term increases in
Kerastick(R) sales levels and/or BLU-U(R) placements. See section entitled
"Management's Discussion and Analysis - Overview, Termination of Dermatology
Collaboration Agreement." A summary of the components of cost of product sales
and royalties for the years ended December 31, 2002 and 2001 including direct
and indirect costs for supporting our product is provided below:



YEAR ENDED DECEMBER 31,
----------------------------------------
INCREASE
2002 2001 (DECREASE)
---------- ---------- ----------

COST OF PRODUCT SALES AND ROYALTIES

Recognition for lower of cost or market inventory
adjustments, increased depreciation taken on BLU-U(R)
units, and deferred charges as a result of the
termination of our collaboration agreement with Schering AG $2,638,000 $ -0- $2,638,000

Internal manufacturing costs (e.g. customer service,
quality assurance, purchasing, and other product support
operations) assigned to products 1,189,000 691,000 498,000

Costs incurred to ship, install and service the BLU-U(R) in
physicians offices including depreciation 834,000 266,000 568,000

Royalty and supply fees (1) 64,000 63,000 1,000

Net underutilization costs (2) 333,000 534,000 (201,000)

Amortization of deferred charges (3) 151,000 226,000 (75,000)

Direct Kerastick(R) product costs including related testing (4) 44,000 369,000 (325,000)
---------- ---------- ----------
Total cost of product sales and royalties $5,253,000 $2,149,000 $3,104,000
========== ========== ==========


1) Royalty and supply fees are paid to our licensor, PARTEQ Research
and Development Innovations, the licensing arm of Queen's
University, Kingston, Ontario.

2) Underutilization costs commenced in 2001 based on an agreement with
our thirty-party Kerastick(R) manufacturer, North Safety Products,
Inc., due to orders falling below certain previously anticipated
levels.

3) Amortization of deferred charges reflects consideration paid by us
in 2000 to amend our Supply Agreement with Sochinaz SA, the
manufacturer of the bulk drug ingredient used in Levulan(R).
Amortization for 2002 reflects amount recorded prior to the
termination of our former dermatology collaboration arrangement.

4) For 2002, direct Kerastick(R) product costs reflect costs
recognized based on direct Kerastick(R) sales since September 1,
2002 to our distributor, Moore Medical Corporation. See section
entitled "Management's Discussion and Analysis - Overview,
Third-party Distribution Agreement."

Historically, inventory costs related to the BLU-U(R) units under rental
or lease were deferred until the BLU-U(R) was no longer returnable to us by the
physician, which was one year under the initial marketing program. As of
December 31, 2002 and 2001, BLU-U units included in property, plant and
equipment amounted to approximately $473,000 and $764,000, net of depreciation
of $473,000 and $69,000. This decrease includes an additional $390,000 of
depreciation expense recorded in 2002 reflecting a shortened useful life of our
BLU-U(R) units under lease, rental, or trial


56


arrangements to reflect a three-year asset life. This accelerated depreciation
policy is attributed to the low level of BLU-U(R) placements to date, the
termination of our former dermatology collaboration arrangement, including the
decision not to launch the BLU-U(R) in non-US markets (except possibly Canada
and/or Brazil) at this time, and management's expectations that near-term
placements will be limited. See Note 3 to the Notes to the Consolidated
Financial Statements - Termination of Dermatology Collaboration Agreement.

RESEARCH AND DEVELOPMENT COSTS - Research and development costs for the
year ended December 31, 2002 were $12,122,000 as compared to $10,790,000 for
2001. This increase in research and development costs for 2002 is attributable
to the write-off of $639,000 of previously deferred royalties associated with
payments to PARTEQ, our licensor, and a $500,000 milestone payment under our
license agreement signed on December 30, 2002 between DUSA and Photonamic GmbH &
Co. KG, a subsidiary of medac GmbH, a German pharmaceutical company. This
agreement provides for the licensing to us of Photonamic's proprietary
technology related to ALA for systemic dosing in the field of brain cancer.
Research and development costs for 2002 also included higher third-party
expenditures in support of our FDA mandated Phase IV clinical study of the
long-term efficacy of our marketed product, clinical feasibility studies in
other dermatological indications, and our Phase I/II clinical studies on the
safety and efficacy of Levulan PDT treatment of Barrett's esophagus with and
without dysplasia. As stated above, under our former agreement with Schering AG,
$2,851,000 of the agreed upon dermatology research and development expenses were
reimbursed to us by Schering AG for 2002 as compared to $2,893,000 for 2001.

The currently approved Levulan(R) Kerastick(R) only allows application of
Levulan(R) to individual lesions using the Kerastick(R), so we are seeking to
apply Levulan(R) to the entire face or scalp in a broad area actinic keratoses
(BAAK) treatment. We are developing a revised protocol for our BLU-U(R)
treatment allowing the use of the Levulan(R) Kerastick(R) for the BAAK
indication after a much shorter drug incubation time. We believe that should
clinical development of this indication be successful and approved as a broader
AK indication, the market penetration of the therapy could be significantly
enhanced. We also intend to complete our FDA-required Phase IV long-term AK
tracking study before the end of 2003.

Data from our Phase I/II study on resistant plantar warts was encouraging,
but was not designed to be statistically significant. However, our Phase II
study on onychomycosis (nail fungus) did not appear to show success in treating
the disease in the majority of patients. Further Phase II development for the
warts and onychomycosis indications are not planned at this time in order to
control our total research and development spending for 2003 and beyond. This
strategy should keep us in a strong financial position as we develop the BAAK
indication, complete the long-term tracking study, and implement activities to
increase revenues from the current product.

We have also been conducting Phase I/II studies in the treatment of
high-grade and low-grade dysplasia associated with Barrett's esophagus. While
limited investigator studies in the high-grade


57

dysplasia indication will still be funded, we do not expect to fund full Phase
II or III clinical trials for this indication on our own. As of January 2003,
with 12 months of follow up in 4 patients, and 6 months in 1 patient, results of
the high-grade dysplasia (HGD) study of five patients showed a continued absence
of dysplasia (i.e. complete ablation), no strictures, and no signs of mucosal
overgrowth. In our low-grade dysplasia (early stage) clinical trial in which the
primary efficacy goal is the conversion of Barrett's esophagus to normal
esophagus, 11 patients have been treated with Levulan PDT and are still being
followed. There was 1 patient in this study that had mild esophageal scarring
without symptoms. We have begun soliciting potential partners for this
indication. Management's goal is to complete a partnership for this indication
during 2003; however, there can be no assurance that we will be able to
consummate any collaboration, or whether we will be able to obtain terms
acceptable to us.

We also anticipate continued funding for various investigator studies
involving the Kerastick(R).

GENERAL AND ADMINISTRATIVE COSTS - General and administrative expenses for
the year ended December 31, 2002 increased to $5,591,000 as compared to
$3,655,000 for 2001. This increase is mainly attributed to higher legal expenses
incurred in 2002 of $1,970,000 as compared to $490,000 in 2001, due primarily to
patent defense costs, the termination of our former dermatology collaboration
arrangement, and strategic initiatives. It is expected that legal expenses will
remain at elevated levels as long as the patent dispute continues. We also
incurred employee separation costs of approximately $395,000 during 2002. There
were no employee separation costs in 2001.

OTHER INCOME - Other income for the year ended December 31, 2002 decreased
to $3,245,000, as compared to $3,845,000 in 2001. This decrease was attributed
to lower interest income of $2,745,000 in 2002 as compared to $3,753,000 in 2001
reflecting a decrease in investable cash balances as we used cash to support our
operating activities, and lower yields. Interest income will continue to decline
as our investable cash balances are reduced to support our operating activities.
Gains on the sale of securities of $500,000 in 2002 partly offset this decline
on interest income as compared to $92,000 in 2001 in order to meet current and
planned operating requirements. During 2002, we incurred interest expense of
$47,000 on borrowings associated with the construction of our new Kerastick(R)
manufacturing facility, which has been capitalized in property and equipment in
the Consolidated Balance Sheet as of December 31, 2002.

INCOME TAXES - Although we had net income for 2002, there was no income
tax expense. The majority of the revenue we recognized in connection with the
termination of the Schering AG agreement had been taxable in prior years for
income tax purposes. As of December 31, 2002, we had net operating loss
carryforwards of approximately $45,125,000 and tax credit carryforwards of
approximately $1,605,000 for Federal reporting purposes. These amounts expire at
various times through 2022. See Note 11 to the Notes to the Consolidated
Financial Statements.


58


NET INCOME (LOSS) - For the year ended December 31, 2002, we earned net
income of $5,763,000, or $.42 cents per share, as compared to a net loss of
($7,358,000), or ($.53) cents per share, for 2001. As a result of the
termination of our former dermatology collaboration arrangement, net income for
2002 included a one-time increase of approximately $17,713,000, excluding normal
amortization recorded prior to termination, based on the acceleration of
previously deferred revenue and costs, and other related adjustments for
impairment. See section entitled "Management's Discussion and Analysis -
Overview, Termination of Dermatology Collaboration Agreement." Subsequent to
2002, we expect to incur net losses until the successful market penetration of
our first products occurs.

RESULTS OF OPERATIONS - YEAR ENDING DECEMBER 31, 2001 AS COMPARED TO 2000

REVENUES - We recognized revenues for the year ended December 31, 2001 of
$5,391,000, as compared to $2,121,000 in 2000. Of these amounts, we earned
research and development revenue of $2,893,000 during 2001 as compared to
$723,000 in 2000 from Schering AG to support our dermatology co-development
program. Also included in revenues were amortization of up-front milestone and
unrestricted grant payments from Schering AG of $1,983,000 in 2001 compared to
$496,000 in 2000, reflecting a full year of amortization in 2001. These
increases were offset by a decline in product sales to $515,000 in 2001 as
compared to $902,000 in 2000, as Berlex filled the distributor's anticipated
Kerastick(R) supply needs, in the fourth quarter of 2000, subsequent to our
September 2000 product launch. We recognized royalty revenues which were earned
when the Kerastick(R) was sold by Berlex to its distributor, and were payable to
us during the quarter following the quarter in which the sales were made. We
recognized supply fee revenue related to these sales when our supplier shipped
the Kerastick(R) to Berlex.

Product sales during 2001 also included rental income on BLU-U(R) units of
approximately $78,000. There was no rental income recognized in 2000. Initially,
we generally leased our BLU-U(R) brand light units for use with the Levulan(R)
Kerastick(R). In July 2001, we test-marketed a new program, which was then
launched nationally in mid-September 2001. Under this program, we rented the
BLU-U(R) to physicians for 36 months with no rental payments incurred by
physicians and no rental revenue recognized by us for the first 6 months,
while Berlex provided physicians with a supply of Kerastick(R) samples.

Under our former agreement with Schering AG, two-thirds of the agreed upon
dermatology research and development expenses, up to $3,000,000 per year for
2000 and 2001, were reimbursed to us by Schering AG. We earned total research
and development reimbursement in 2001 of $2,893,000. Based on the agreed upon
development plan and the timing of the start of the clinical trials, we were
only entitled to reimbursement of $723,000 for the year ended December 31, 2000.

The total amount of up-front milestone and unrestricted grant payments
received in 2000 and 1999 were recorded as deferred revenue upon receipt and
were recognized as income on a straight-line basis over the stated term of our
terminated agreement with Schering AG. For the years ended


59


December 31, 2001 and 2000, approximately $1,983,000 and $496,000, respectively,
of up-front milestone and unrestricted grant payments were reflected in
revenues.

COST OF PRODUCT SALES AND ROYALTIES - Cost of product sales and royalties
for the year ended December 31, 2001 were $2,149,000, as compared to $1,105,000
in 2000. A summary of the components of cost of product sales and royalties for
the years ended December 31, 2001 and 2000 including direct and indirect costs
for supporting our product is listed below:



YEAR ENDED DECEMBER 31,
--------------------------------------------
INCREASE
2001 2000 (DECREASE)
---------- --------- -----------

COST OF PRODUCT SALES AND ROYALTIES

Internal manufacturing costs (e.g. customer service,
quality assurance, purchasing, and other product
support operations) assigned to support products (1) $ 691,000 -- $ 691,000

Costs incurred to ship, install, and service the BLU-U(R)
in physicians offices including depreciation 266,000 128,000 138,000

Royalty and supply fees to DUSA's licensor (2) 63,000 68,000 (5,000)

Net underutilization costs (3) 534,000 -- 534,000

Amortization of deferred charges (4) 226,000 113,000 113,000

Direct Kerastick(R) product costs including related testing 369,000 796,000 (427,000)
---------- --------- -----------
Total cost of product sales and royalties $2,149,000 1,105,000 $ 1,044,000
========== ========= ===========


1) Allocation of internal support costs assigned to support product
commenced in 2001 as a significant percentage of manufacturing
development activities have been completed for our current products.

2) Royalty and supply fees are paid to our licensor, PARTEQ Research
and Development Innovations, the licensing arm of Queen's
University, Kingston, Ontario.

3) Underutilization costs commenced in 2001 based on an agreement with
our third-party Kerastick(R) manufacturer, North Safety Products,
Inc., due to orders falling below certain previously anticipated
levels.

4) Amortization of deferred charges reflects consideration paid by us
in 2000 to amend our Supply Agreement with Sochinaz SA, the
manufacturer of the bulk drug ingredient used in Levulan(R).

Inventory costs related to the BLU-U(R) commercial light sources under
rental or lease were deferred and recorded in other current assets until the
BLU-U(R) was no longer returnable to us by the physician, which was 1 year under
the initial marketing program. As of December 31, 2001 and 2000, deferred
inventory costs were approximately $764,000 and $262,000.

RESEARCH AND DEVELOPMENT COSTS - Our research and development costs for
the year ended December 31, 2001 were approximately $10,790,000, as compared to
$8,163,000 in 2000. The increase for 2001 was attributable to higher third-party
expenditures for dermatology and internal indications coupled with increased
personnel costs related to ongoing development activities. During 2001, this
increase was partially offset by the reassignment of personnel costs to product
sale


60


operations and/or general and administrative functions, rather than to research
and development costs, as a significant percentage of the development activities
were completed for our currently marketed dermatology products in 2000. As
stated above under "Management's Discussion and Analysis - Revenues," under our
agreement with our former marketing partner, two-thirds, or $2,893,000, of the
agreed upon dermatology research and development expenses were reimbursable to
us by Schering AG for 2001 as compared to $723,000 for 2000.

GENERAL AND ADMINISTRATIVE COST - General and administrative costs for the
year ended December 31, 2001 were $3,655,000, as compared to $2,616,000 for
2000. The increase for 2001 was mainly attributable to the hiring of additional
staff commencing in the second half of 2000 through the first half of 2001,
including key management personnel in administrative, financial, information
technology, and operations functions.

OTHER INCOME - Other income for the year ended December 31, 2001 was
approximately $3,845,000, as compared to $3,222,000 for 2000. The increase for
2001 mainly reflected earnings on higher investable cash balances as a result of
the $15,000,000 received from our former marketing partner during the fourth
quarter of 2000, and the full year impact of approximately $40,700,000 in net
proceeds received from a private placement of our common stock in March 2000.

NET LOSSES - For the year ended December 31, 2001, we incurred a net loss
of approximately ($7,358,000), or ($0.53) per share, as compared to
($6,541,000), or ($0.49) per share, in 2000. These losses were within
management's expectations.

RELATED PARTY TRANSACTIONS

Our Vice President of Technology and former Vice President of Business
Development are principal shareholders of Lumenetics, Inc., our former light
device consultants. During 2000, we paid $2,000 for certain equipment leased
under operating leases from Lumenetics. In 2001, we purchased this equipment for
$52,000. All transactions were executed at prices estimated to be fair market
values.


61


QUARTERLY RESULTS OF OPERATIONS

The following is a summary of the quarterly results of operations for the
years ended December 31, 2002 and 2001, respectively:



Quarterly Results For Year Ended December 31, 2002
---------------------------------------------------------------------
March June September December
31 30 30 31
----------- ----------- ------------ -----------

Total revenues $ 1,325,498 $ 1,429,978 $ 22,565,754 $ 162,008

Income (loss) from operations (3,641,970) (4,222,468) 15,065,172 (4,683,565)

Net income (loss) (2,867,551) (3,437,566) 15,760,873 (3,693,238)

Basic and diluted income (loss)
per share (0.21) (0.25) 1.13 (0.27)




Quarterly Results For Year Ended December 31, 2001
---------------------------------------------------------------------
March June September December
31 30 30 31
----------- ----------- ------------ -----------

Total revenues $ 1,189,960 $ 1,516,754 $ 1,436,566 $ 1,247,456

Loss from operations (2,354,838) (2,495,046) (2,795,961) (3,557,111)

Net loss (1,252,060) (1,563,335) (1,817,029) (2,725,672)

Basic and diluted loss per share (0.09) (0.11) (0.13) (0.20)


LIQUIDITY AND CAPITAL RESOURCES

We are in a strong cash position to continue to fund our research and
development activities for our Levulan(R) PDT/PD dermatology platform. Our total
assets were $60,950,000 as of December 31, 2002 compared to $75,864,000 as of
December 31, 2001. This decrease is attributable to the funding of net operating
activities during 2002.

As of December 31, 2002, we had inventory of $1,189,000, representing
finished goods and raw materials, as compared to $2,333,000 as of December 31,
2001. Also, as of December 31, 2002, we had net property and equipment of
$5,230,000, as compared to $4,148,000 as of December 31, 2001, due primarily to
construction costs associated with our new manufacturing facility.

As of December 31, 2002, we had accounts receivable of $37,000 as compared
to $121,000 as of December 31, 2001, representing net sales associated with
Kerastick(R) product sales. In addition, a receivable of $865,000 had been
recorded as a current asset as of December 31, 2001 reflecting an amount
reimbursable by our former marketing partner for research and development costs
under our agreement. For 2002, based on the termination of this agreement, we
received


62


payments for reimbursement of research and development costs to which we were
entitled prior to December 31, 2002.

As of December 31, 2002, we had current liabilities of $3,375,000, as
compared to $3,051,000 as of December 31, 2001. Prior to 2002, we had no
long-term debt; however, in May 2002 we entered into a secured term loan
promissory note ("Note") with Citizens Bank of Massachusetts to fund the
construction of our manufacturing facility and borrowed $1,900,000 of a
$2,700,000 commitment, of which the remaining amount lapsed on June 30, 2002. On
August 1, 2002, we commenced monthly loan payments with fixed monthly principal
payments of $22,500 plus interest, which are scheduled to continue through June
30, 2009. Interest in the first year of the loan is based on a 360-day
LIBOR-based rate, which resulted in a 4% interest rate for the initial year of
the Note. Prior to expiration of the 360-day LIBOR-based rate for each year of
the loan, we can either continue to choose a LIBOR-based rate at that time,
execute a one-time conversion to a fixed rate loan, or repay the loan balance.
As of December 31, 2002, the total outstanding loan balance is $1,787,500, of
which $270,000 is current. Approximately $3,000,000 of the Company's United
States government securities are pledged as collateral to secure the loan.

We invest our cash in United States government securities, all of which
are classified as available for sale. These securities have an aggregate cost of
$43,180,000, and a current aggregate market value of $45,815,000 as of December
31, 2002, resulting in a net unrealized gain on securities available for sale of
$2,635,000, which has been included in shareholders' equity. As of December 31,
2001, government securities had an aggregate cost of $54,917,000 and an
aggregate market value of $57,141,000, resulting in a net unrealized gain of
$2,224,000. Due to fluctuations in interest rates and depending upon the timing
of our need to convert government securities into cash to meet our working
capital requirements, some gains or losses could be realized. As of December 31,
2002, these securities had interest rates and yields ranging from 3.95% to 7.21%
and maturity dates ranging from January 21, 2003 to February 15, 2007. As of
December 31, 2001, these securities had interest rates and yields ranging from
4.26% to 7.00% and maturity dates ranging from January 14, 2002 to November 15,
2006.

We believe that we have sufficient capital resources to proceed with our
current dermatology research, development, manufacturing, and marketing programs
for Levulan(R) PDT, and to fund operations and capital expenditures for the
foreseeable future, particularly with the current reduction in research and
development spending. We have invested our funds in liquid investments, so that
we will have ready access to these cash reserves, as needed, for the funding of
development plans on a short-term and long-term basis.

We are currently focusing our near-term research and development efforts
on our dermatology development program to treat BAAK. As a result of the
termination of our former dermatology collaboration arrangement, we have
reevaluated our operations and intend to minimize research and development and
related general and administrative expenditures that are not directly related to
our core objectives for 2003. We also intend to invest in research, development,
manufacturing, and marketing programs for Levulan(R) PDT in support of our
efforts to penetrate the


63


marketplace with our unique Levulan(R) PDT therapy for AKs. We may seek to
expand or enhance our business by using resources to acquire by license,
purchase or other arrangements, businesses, new technologies, or products,
especially in PDT-related areas. However, at this time, we intend to focus
primarily on increasing the sales of dermatology products, and on seeking a
partner to help develop and market Levulan(R) PDT for the treatment of dysplasia
in patients with Barrett's esophagus. Full development and testing of all
potential indications would require additional funding. The timing of
expenditures will be dependent on various factors, including:

- the level of sales of our first products including the success of
our marketing programs based on reacquiring the rights to
Levulan(R) PDT,

- progress of our research and development programs,

- the results of preclinical and clinical trials,

- the timing of regulatory marketing approvals,

- competitive developments,

- the results of patent disputes,

- any new additional collaborative arrangements, if any, we may enter,
and

- the availability of other financing.

We cannot accurately predict the magnitude of revenues from sales of our
products. While the net proceeds of the January 1999 and March 2000 common stock
offerings coupled with payments received from our former marketing partner will
enable us to maintain our current research program as planned and support the
commercialization of Levulan(R) PDT for AKs for the foreseeable future, in order
to maintain and expand continuing research and development programs, we may need
to raise additional funds through future corporate alliances, financings, or
other sources, depending upon the amount of revenues we receive from our first
product.

Additionally, we may have to establish a marketing capability, also at
significant expense.

As of December 31, 2002, we had 43 full-time employees. Our staffing
levels for key management personnel in administrative, financial, technical and
operations functions had been established to support the sales levels of
Levulan(R) PDT that did not materialize. However, following the reacquisition of
our product rights, we downsized our staffing levels by approximately 20%. Also,
during the fourth quarter of 2002, both our Vice President of Regulatory Affairs
and Vice President of Business Development ended their employment with us;
however, they are consulting on a part-time, as-needed, basis. We have
employment agreements with our key executive officers. We have purchased and are
the named beneficiary of a key man life insurance contract having a face value
of CDN $2,000,000 on the life of our President.

We have incurred certain environmental control costs as part of our
development of a production line for Kerastick(R) manufacturing to ensure that
our facility complies with environmental standards. We have estimated that the
capital costs to develop this facility, including equipment, will


64

\
be approximately $2,700,000, most of which has been expended. There can be no
assurance, however, that we will not be required to incur significant additional
costs to comply with environmental laws and regulations in the future, or any
assurance that our operations, business or assets will not be materially
adversely affected by current or future environmental laws or regulations. See
section entitled "Business - Government Regulation."

CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS

Our contractual obligations and other commercial commitments to make
future payments under contracts, such as lease agreements, research and
development contracts, manufacturing contracts, or other related agreements are
as follows at December 31, 2002 are listed below:



Obligations Due by Period
----------------------------------------------------------------------
1 Year or After 5
Total Less 2-3 Years 4-5 Years Years
---------- ---------- --------- --------- ----------

Operating lease obligations (1) $4,113,000 $ 401,000 $882,000 $810,000 $2,020,000

Research and development projects (2) $4,200,000 $3,433,000 767,000 -- --

Manufacturing facility development (3) $ 100,000 $ 100,000 -- -- --

Secured term loan promissory note (4) $1,787,500 $ 270,000 $540,000 $540,000 $ 437,500


1) In 2001, we extended our lease for office and manufacturing space in
our Wilmington, Massachusetts headquarters through November 2016. We
have the ability to terminate the Wilmington lease after the 10th
year (2011) of the lease by providing the landlord with notice at
least 7 1/2 months prior to the date on which the termination would
be effective. In August 2002, we entered into a 5 year lease for our
new Toronto location. In October 2002, we also entered into a new 5
year lease at our Valhalla location, and have the ability to
terminate the Valhalla lease after the 3rd year. The operating lease
obligations disclosed above include payments for the non-cancelable
term of all operating leases.

2) We have estimated that the proposed development, including clinical
studies relating to a broader Levulan(R)PDT AK treatment, rather
than individual AK lesions, to the face and scalp could cost
approximately $2,300,000, with $1,533,000 and $767,000 expected to
be incurred in 2003 and 2004, respectively. We will be in a better
position to estimate this commitment as we work with the FDA to
determine the necessary protocols. In addition to the obligations
disclosed above, we have contracted with Therapeutics, Inc., a
clinical research organization, to manage the clinical development
of our products in the field of dermatology. This organization has
the opportunity for additional stock grants, bonuses, and other
incentives for each product indication ranging from $250,000 to
$1,250,000, depending on the regulatory phase of development of
products under Therapeutics' management.

3) We commenced the construction of a Kerastick(R) manufacturing
facility at our Wilmington, Massachusetts location in January 2002.
The initial build-out was


65

completed in June 2002, and we commenced facility qualification,
process validation, and drug product stability testing, which is
expected to take approximately 6 months and be completed in early
2003. FDA review and approval is also expected to take 6 months,
with an estimated completion date in late 2003. This review process
should commence after the completion of all validation and certain
stability activities, as well as the preparation and submission of
an NDA supplement. We have estimated that the cost to build and
complete testing of this facility, including equipment, will be
approximately $2,700,000. This cost includes estimates to build the
facility and all costs of construction, calibration, validation
testing and equipment. As of December 31, 2002, the Company has
capitalized $2,596,000 for this facility.

4) In May 2002, we entered into a secured term loan promissory note
("Note") with Citizens Bank of Massachusetts to fund the
construction of its manufacturing facility and borrowed $1,900,000
with fixed monthly principal payments of $22,500 plus interest,
which are scheduled to continue through June 30, 2009.

RECENTLY ISSUED ACCOUNTING GUIDANCE

In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment of Disposal of Long-lived Assets." This statement supercedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." SFAS 144 establishes a single accounting model, based
on the framework established in SFAS 121, for long-lived assets to be disposed
of by sale, and resolves implementation issues related to SFAS 121. SFAS No. 144
is effective for fiscal years beginning after December 15, 2001 and interim
periods within those fiscal years. On January 1, 2002, DUSA adopted this
statement, which had no effect on our financial position or results of
operations upon adoption.

In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an amendment of FASB SFAS
No. 123, "Accounting for Stock-Based Compensation" to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, SFAS No. 148
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect on the method
used on reported results. We have determined that we will continue to account
for stock-based compensation to employees under the provisions of APB Opinion
No. 25 and will make all required disclosures in our financial reports to comply
with SFAS 148.

In December 2002, the EITF reached conclusion on EITF Issue No. 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." This consensus
provides guidance in determining when a revenue arrangement with multiple
deliverables should be divided into separate


66


units of accounting, and, if separation is appropriate, how the arrangement
consideration should be allocated to the identified accounting units. The
provisions of EITF No. 00-21 are effective for revenue arrangements entered into
in fiscal periods beginning after June 15, 2003. We will evaluate multiple
element arrangements in accordance with this EITF upon its effective date for
new arrangements into which it enters.

INFLATION

Although inflation rates have been comparatively low in recent years,
inflation is expected to apply upward pressure on our operating costs. We have
included an inflation factor in our cost estimates. However, the overall net
effect of inflation on our operations is expected to be minimal.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We hold fixed income United States government securities that are subject
to interest rate market risks. However, we do not believe that the risk is
material as we make our investments in relatively short-term instruments and we
strive to match the maturity dates of these instruments to our cash flow needs.
A 10% decline in the average yield of these instruments would reduce interest
income by approximately $258,000 based on our December 31, 2002 balance in U.S.
government securities.

We currently have exposure to interest rate risk under a secured term loan
promissory note which we issued to fund the construction of our manufacturing
facility. Interest on this loan is at a LIBOR-based rate, and calls for an
annual renewal on June 30th of each year through June 30, 2009 to either the
applicable LIBOR-based rate or a one-time conversion to a fixed rate loan. The
current loan rate is based on a LIBOR rate of 1.75% (LIBOR is 1.45% at December
31, 2002). Our exposure to interest rate risk due to changes in LIBOR is not
expected to be material.

FORWARD-LOOKING STATEMENTS SAFE HARBOR

This report, including the Management's Discussion and Analysis, contains
various "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933 which represent our expectations or beliefs concerning
future events, including, but not limited to statements regarding management's
beliefs regarding the unique nature of Levulan(R) and its use and potential use,
expectations regarding the timing of results of clinical trials and future
development of warts, onychomycosis, facial photodamaged skin, acne, Barrett's
esophagus dysplasia and other potential indications, intention to pursue
licensing, or acquisition opportunities, status of clinical programs for all
other indications and beliefs regarding potential efficacy and marketing, our
intention to develop a sales force, hope that our products will be an AK therapy
of choice and barriers to achieving that status, beliefs regarding revenues from
approved and potential products and Levulan's(R) competitive properties,
intention to postpone or commence clinical trials and investigator studies in
2003, expectations of exclusivity under the Hatch/Waxman Act and other patent
laws,


67

intentions to seek additional United States and foreign regulatory approvals,
trademarks, and to market outside the United States, beliefs regarding
environmental compliance, beliefs concerning patent disputes, the impact of a
third-party's regulatory compliance and fulfillment of contractual obligations,
plans to monitor cost of product sales, expectations of increases in cost of
product sales, expected use of cash resources in 2003, requirements of cash
resources for our future liquidity, anticipation of hiring additional personnel,
effect of reimbursement policies on revenues, expectations for future strategic
opportunities and research and development programs, expectations for continuing
operating losses, expectations regarding the adequacy and availability of
insurance, stable administrative costs, status of research and development
costs, levels of interest income and our capital resource needs, intention to
sell securities to meet capital requirements, expectations for completion of our
new manufacturing facilities and its expected costs, and anticipated dates for
inspection and testing, beliefs regarding the adequacy of our inventory of
Kerastick(R) units, belief regarding interest rate risks to our investments and
effects of inflation and new accounting standards, dependence on key personnel,
beliefs concerning product liability insurance, intention to continue to develop
integrated drug and light device systems, belief that our new facility will help
control costs and our principal methods of competition. These forward-looking
statements are further qualified by important factors that could cause actual
results to differ materially from those in the forward-looking statements. These
factors include, without limitation, changing market and regulatory conditions,
actual clinical results of our trials, the impact of competitive products and
pricing, the timely development, FDA and foreign regulatory approval, and market
acceptance of our products, reliance on third-parties for the production,
manufacture, sales and marketing of our products, the securities regulatory
process, the maintenance of our patent portfolio and ability to obtain
competitive levels of reimbursement by third-party payors, none of which can be
assured. Results actually achieved may differ materially from expected results
included in these statements as a result of these or other factors.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



Independent Auditors' Report................................................ F-1
Consolidated Balance Sheets................................................. F-2
Consolidated Statements of Operations....................................... F-3
Consolidated Statements of Shareholders' Equity............................. F-4
Consolidated Statements of Cash Flows....................................... F-5
Notes to the Consolidated Financial Statements.............................. F-7


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.


68


PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by Item 10 is hereby incorporated by reference to
the sections entitled "Nominees," "Executive Officers who are not Directors,"
and "Compliance with Section 16(a) of the Exchange Act" of the Registrant's 2003
Proxy Statement.

ITEM 11. EXECUTIVE COMPENSATION

The information required by Item 11 is hereby incorporated by reference to
the sections entitled "Director Compensation," "Executive Compensation," "Board
Compensation Committee Report on Executive Compensation," "Performance Graph,"
"Option Grants in 2002," "Aggregate Option Exercises in 2002 and Option Values
at December 31, 2002," and "Other Compensation" of Registrant's 2003 Proxy
Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by Item 12 is hereby incorporated by reference to
the section entitled "Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters" of the Registrant's 2003 Proxy
Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by Item 13 is hereby incorporated by reference to
the section entitled "Certain Transactions" of the Registrant's 2003 Proxy
Statement.

ITEM 14. CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

D. Geoffrey Shulman, our principal executive officer and principal
financial officer, has reviewed and evaluated the effectiveness of our
disclosure controls and procedures (as defined in Exchange Act Rules
240.13a-14(c) and 15d-14(c)) as of a date within 90 days before the filing date
of this annual report. Based on that evaluation, Dr. Shulman has concluded that
our current disclosure controls and procedures are effective in timely providing
him with material information relating to us which is required to be disclosed
in the reports we file or submit under the Exchange Act.


69


CHANGES IN INTERNAL CONTROLS

There have been no significant changes in our internal controls or in
other factors that could significantly affect internal controls subsequent to
the date we carried out this evaluation.

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

A. List of Financial Statements and Schedules



Page
Number
------

INCLUDED IN ANNUAL REPORT TO SHAREHOLDERS
INCORPORATED HEREIN BY REFERENCE:

Independent Auditors' Report...................................................................... F-1
Consolidated Balance Sheets....................................................................... F-2
Consolidated Statements of Operations............................................................. F-3
Consolidated Statements of Shareholders' Equity................................................... F-4
Consolidated Statements of Cash Flows............................................................. F-5
Notes to the Consolidated Financial Statements.................................................... F-7


Schedules are omitted because they are not required or the information is
included in Notes to the Consolidated Financial Statements.

B. Reports on Form 8-K

a) Form 8-K, filed on October 11, 2002, announcing the adoption
on September 27, 2002 of a Shareholder Rights Plan and the
declaration of a dividend distribution of one preferred share
purchase right to each shareholder of record on October 10,
2002.

C. Exhibits filed as part of this Report

3(a)(i) Certificate of Incorporation, as amended, filed as Exhibit
3(a) to the Registrant's Form 10-K for the fiscal year ended
December 31, 1998, and is incorporated herein by reference;

3(a)(ii) Certificate of Amendment to the Certificate of Incorporation,
as amended, dated October 28, 2002 and filed as Exhibit 99.3
to the Registrant's Quarterly Report on Form 10-Q for the
fiscal quarter ended September 30, 2002, filed November 12,
2002 and incorporated herein by reference; and

3(b) By-laws of the Registrant, filed as Exhibit 3(ii) to the
Registrant's Quarterly Report on Form 10-Q for the fiscal
quarter ended September 30, 1997, filed November 12, 1997 and
are incorporated herein by reference.

4(a) Common Stock specimen;


70


4(b) Class B Warrant, filed as Exhibit 4.3 to the Registrant's
Registration Statement on Form S-1, No. 33-43282, and is
incorporated herein by reference;

4(c) Rights Agreement filed as Exhibit 4.0 to Registrant's Current
Report on Form 8-K dated September 27, 2002, filed October 11,
2002, and is incorporated herein by reference; and

4(d) Rights Certificate relating to the rights granted to holders
of common stock under the Rights Agreement filed as Exhibit
4.0 to Registrant's Current Report on Form 8-K, dated
September 27, 2002, filed October 11, 2002, and is
incorporated herein by reference.

10(a) License Agreement between the Company, PARTEQ and Draxis
Health Inc. dated August 27, 1991, filed as Exhibit 10.1 to
the Registrant's Registration Statement on Form S-1, No.
33-43282, and is incorporated herein by reference;

10(b) ALA Assignment Agreement between the Company, PARTEQ, and
Draxis Health Inc. dated October 7, 1991, filed as Exhibit
10.2 to the Registrant's Registration Statement on Form S-1,
No. 33-43282, and is incorporated herein by reference;

10(b.1) Amended and Restated Assignment Agreement between the Company
and Draxis Health, Inc. dated April 16, 1999, filed as Exhibit
10(b.1) to the Registrant's Form 10-K for the fiscal year
ended December 31, 1999, and is incorporated herein by
reference;

10(c) Employment Agreement of D. Geoffrey Shulman, MD, FRCPC dated
October 1, 1991, filed as Exhibit 10.4 to the Registrant's
Registration Statement on Form S-1, No. 33-43282, and is
incorporated herein by reference;

10(d) Amendment to Employment Agreement of D. Geoffrey Shulman, MD,
FRCPC dated April 14, 1994, filed as Exhibit 10.4 to the
Registrant's Registration Statement on Form S-2, No. 33-98030,
and is incorporated hereby by reference;

10(e) Amended and Restated License Agreement between the Company and
PARTEQ dated March 11, 1998, filed as Exhibit 10(e) to the
Registrant's Form 10-K/A filed on June 18, 1999, portions of
Exhibit A have been omitted pursuant to a request for
confidential treatment pursuant to Rule 24b-2 of the
Securities Exchange Act of 1934, as amended, and is
incorporated herein by reference;

10(f) Incentive Stock Option Plan, filed as Exhibit 10.11 of
Registrant's Registration Statement on Form S-1, No. 33-43282,
and is incorporated herein by reference;

10(g) 1994 Restricted Stock Option Plan, filed as Exhibit 1 to
Registrant's Schedule 14A definitive Proxy Statement dated
April 26, 1995, and is incorporated herein by reference;


71


10(h) 1996 Omnibus Plan, as amended, filed as Appendix A to
Registrant's Schedule 14A Definitive Proxy Statement dated
April 26, 2001, and is incorporated herein by reference;

10(i) Purchase and Supply Agreement between the Company and National
Biological Corporation dated November 5, 1998, filed as
Exhibit 10(i) to the Registrant's Form 10-K/A filed on June
18, 1999, portions of which have been omitted pursuant to a
request for confidential treatment pursuant to Rule 24b-2 of
the Securities Exchange Act of 1934, as amended, and is
incorporated herein by reference;

10(j) Common Stock Purchase Agreement between the Company and
Schering Berlin Venture Corporation dated as of November 22,
1999, filed as Exhibit 10.2 to the Registrant's Current Report
on Form 8-K dated November 22, 1999, portions of which have
been omitted pursuant to a request for confidential treatment
pursuant to Rule 24b-2 of the Securities Exchange Act of 1934,
as amended, and is incorporated herein by reference;

10(k) Purchase and Supply Agreement between the Company and North
Safety Products, Inc. dated as of September 13, 1999, filed as
Exhibit 10.1 to the Registrant's Current Report on Form 8-K
dated October 14, 1999, portions of which have been omitted
pursuant to a request for confidential treatment pursuant to
Rule 24b-2 of the Securities Exchange Act of 1934, as amended,
and is incorporated herein by reference;

10(k.1) Amendment to Purchase and Supply Agreement between the Company
and North Safety Products, Inc. dated as of February 15, 2001,
portions of which have been omitted pursuant to a request for
confidential treatment pursuant to Rule 24b-2 of the
Securities Exchange Act of 1934, as amended, filed as Exhibit
10(p.1) to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 2001, filed on March 15, 2002,
and is incorporated herein by reference;

10(k.2) Second Amendment to Purchase and Supply Agreement between the
Company and North Safety Products, Inc. dated as of July 26,
2001, portions of which have been omitted pursuant to a
request for confidential treatment pursuant to Rule 24b-2 of
the Securities Exchange Act of 1934, as amended, filed as
Exhibit 10(p.2) to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 2001, filed on March
15, 2002, and is incorporated herein by reference;

10(l) Supply Agreement between the Company and Sochinaz SA dated
December 24, 1993, filed as Exhibit 10(q) to Registrant's Form
10-K/A filed on March 21, 2000, portions of which have been
omitted pursuant to a request for confidential treatment
pursuant to Rule 24b-2 of the Securities Exchange Act of 1934,
as amended, and is incorporated herein by reference;

10(l.1) First Amendment to Supply Agreement between the Company and
Sochinaz SA dated July 7, 1994, filed as Exhibit 10(q.1) to
Registrant's Annual Report on Form


72


10-K for the fiscal year ended December 31, 1999, and is
incorporated herein by reference;

10(l.2) Second Amendment to Supply Agreement between the Company and
Sochinaz SA dated as of June 20, 2000, filed as Exhibit 10.1
to Registrant's Current Report on Form 8-K dated June 28,
2000, and is incorporated herein by reference;

10(m) Master Service Agreement between the Company and Therapeutics,
Inc. dated as of October 4, 2001, filed as Exhibit 10(b) to
the Registrant's Quarterly Report on Form 10-Q for the fiscal
quarter ended September 30, 2001, filed November 8, 2001,
portions of which have been omitted pursuant to a request for
confidential treatment under Rule 24b-2 of the Securities
Exchange Act of 1934, as amended and is incorporated herein by
reference;

10(n) Commercial Loan Agreement, Secured Term Loan Promissory Note
and Pledge and Security Agreement between the Company and
Citizens Bank of Massachusetts dated May 13, 2002 filed as
Exhibit 99.1 to the Registrant's Quarterly Report on Form 10-Q
for the fiscal quarter ended March 31, 2002, filed May 14,
2002, and is incorporated herein;

10(o) Collaboration Termination Agreement, effective September 1,
2002, between DUSA and Schering AG, the Company's former
marketing partner, filed as Exhibit 10 to Registrant's Current
Report on Form 8-K dated August 27, 2002, and is incorporated
herein by reference;

10(p) Wholesale Distribution Agreement, effective September 1, 2002,
between DUSA and Moore Medical Corporation, filed as Exhibit
10.1 to the Registrant's Quarterly Report on Form 10-Q for the
fiscal quarter ended September 30, 2002, filed November 12,
2002, portions of which have been omitted pursuant to a
request for confidential treatment pursuant to Rule 24b-2 of
the Securities Exchange Act of 1934, and is incorporated
herein by reference;

10(q) Program Agreement between the Company and Auric Capital Corp.
dated April 18, 2002, filed as Exhibit 10.1 to the
Registrant's Quarterly Report on Form 10-Q for the fiscal
quarter ended March 31, 2002, filed on May 14, 2002, portions
of which have been omitted pursuant to a request for
confidential treatment under Rule 24b-2 of the Securities
Exchange Act of 1934, as amended, and is incorporated herein
by reference;

10(r) License and Development Agreement between DUSA
Pharmaceuticals, Inc. and Photonamic GmbH & Co. KG dated as of
December 30, 2002, portions of which have been omitted
pursuant to a request for confidential treatment under Rule
24(b)-2 of the Securities Exchange Act of 1934, as amended;
and

10(s) Supply Agreement between DUSA Pharmaceuticals, Inc. and medac
GmbH dated as of December 30, 2002, portions of which


73


have been omitted pursuant to a request for confidential
treatment under Rule 24(b)-2 of the Securities Exchange Act of
1934, as amended.

23 Independent Auditors' Consent of Deloitte & Touche LLP.

99(a) Certification of the Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002; and

99(b) Press Release dated March 11, 2003.


74


INDEPENDENT AUDITORS' REPORT

Board of Directors
DUSA Pharmaceuticals, Inc.
Wilmington, Massachusetts

We have audited the accompanying consolidated balance sheets of DUSA
Pharmaceuticals, Inc. and its subsidiary (the "Company") as of December 31, 2002
and 2001, and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 2002
and 2001, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America.


/s/ DELOITTE & TOUCHE LLP

Boston, Massachusetts
February 14, 2003


F-1


DUSA PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS



DECEMBER 31,
----------------------------
2002 2001
------------ ------------

ASSETS

CURRENT ASSETS
Cash and cash equivalents $ 7,064,596 $ 7,568,500
United States government securities 45,814,947 57,141,125
Accrued interest receivable 699,664 923,459
Accounts receivable 36,720 121,280
Receivable under co-development program -- 864,534
Inventory, net 1,188,659 2,333,080
Prepaids and other current assets 915,704 490,925
------------ ------------
TOTAL CURRENT ASSETS 55,720,290 69,442,903
Property, plant and equipment, net 5,229,683 4,148,311
Deferred charges and royalty -- 2,273,007
------------ ------------
TOTAL ASSETS $ 60,949,973 $ 75,864,221
============ ============

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES
Accounts payable $ 552,891 $ 314,889
Accrued payroll 476,602 681,190
Other accrued expenses 2,070,150 1,781,085
Current maturities of long-term debt 270,000 --
Deferred revenue 5,100 273,358
------------ ------------
TOTAL CURRENT LIABILITIES 3,374,743 3,050,522
Long-term debt, net of current 1,517,500 --
Deferred revenue -- 22,312,498
Other deferred reimbursement -- 666,664
------------ ------------
TOTAL LIABILITIES 4,892,243 26,029,684
------------ ------------
Commitments and Contingencies (Note 14)

SHAREHOLDERS' EQUITY
Capital Stock
Authorized: 100,000,000 shares; 40,000,000 shares designated as common stock, no par,
60,000,000 shares issuable in series or classes; and 40,000 junior Series A preferred shares
Issued and outstanding: 13,887,612 (2001: 13,865,390) shares of common stock, no par 95,490,561 95,440,561
Additional paid-in capital 2,015,586 2,015,586
Accumulated deficit (44,082,927) (49,845,445)
Accumulated other comprehensive income 2,634,510 2,223,835
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 56,057,730 49,834,537
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 60,949,973 $ 75,864,221
============ ============


See the accompanying Notes to the Consolidated Financial Statements.


F-2


DUSA PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS



YEAR ENDED DECEMBER 31,
------------------------------------------------
2002 2001 2000
----------- ------------ ------------

REVENUES
Product sales and rental income $ 319,378 $ 514,584 $ 902,154
Research grant and milestone revenue 22,312,498 1,983,336 495,833
Research revenue earned under collaborative agreement 2,851,362 2,892,816 722,570
----------- ------------ ------------
TOTAL REVENUES 25,483,238 5,390,736 2,120,557
----------- ------------ ------------
OPERATING COSTS
Cost of product sales and royalties 5,253,424 2,148,994 1,104,664
Research and development 12,121,606 10,789,906 8,163,419
General and administrative 5,591,039 3,654,792 2,615,502
----------- ------------ ------------
TOTAL OPERATING COSTS 22,966,069 16,593,692 11,883,585
----------- ------------ ------------
INCOME (LOSS) FROM OPERATIONS 2,517,169 (11,202,956) (9,763,028)
----------- ------------ ------------

OTHER INCOME, NET
Interest income 2,745,143 3,753,019 3,222,273
Realized gain on sale of United States government securities 500,206 91,841 --
----------- ------------ ------------
TOTAL OTHER INCOME 3,245,349 3,844,860 3,222,273
----------- ------------ ------------
NET INCOME (LOSS) $ 5,762,518 $ (7,358,096) $ (6,540,755)
=========== ============ ============
BASIC AND DILUTED NET INCOME (LOSS) PER COMMON SHARE $ .42 $ (.53) $ (.49)
=========== ============ ============
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 13,877,566 13,791,735 13,285,472
=========== ============ ============


See the accompanying Notes to the Consolidated Financial Statements.


F-3


DUSA PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY



ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
NUMBER OF PAID-IN ACCUMULATED COMPREHENSIVE
SHARES AMOUNT CAPITAL DEFICIT INCOME TOTAL
----------- ----------- ----------- ------------ ------------- ------------

BALANCE, JANUARY 1, 2000 11,908,357 $51,749,987 $1,338,854 $(35,946,594) $ (82,319) $ 17,059,928
---------- ----------- ---------- ------------ ---------- ------------
Comprehensive loss:
Net loss for period (6,540,755) (6,540,755)
Net unrealized gain on
United States government
securities available for
sale 1,261,413 1,261,413
------------
Total comprehensive loss $ (5,279,342)
Issuance of common stock for cash
(net of offering costs
of $2,051,714) 1,500,000 40,698,286 40,698,286
Issuance of common stock in
connection with
supply agreement 26,667 750,000 750,000
Issuance of common stock to
consultant 2,500 64,533 64,533
Exercises of options 248,350 1,264,646 1,264,646
Exercises of warrants 45,016 230,080 230,080
Stock based compensation 521,665 521,665
---------- ----------- ---------- ------------ ---------- ------------
BALANCE, DECEMBER 31, 2000 13,730,890 $94,757,532 $1,860,519 $(42,487,349) $1,179,094 $ 55,309,796
---------- ----------- ---------- ------------ ---------- ------------
Comprehensive loss:
Net loss for period (7,358,096) (7,358,096)
Net unrealized gain on United
States government securities
available for sale (net of
realized gains of $91,841) 1,044,741 1,044,741
------------
Total comprehensive loss $ (6,313,355)
Issuance of common stock to
consultant 5,000 54,750 54,750
Exercises of options 104,500 478,279 478,279
Exercises of warrants 25,000 150,000 150,000
Stock based compensation 155,067 155,067
---------- ----------- ---------- ------------ ---------- ------------
BALANCE, DECEMBER 31, 2001 13,865,390 $95,440,561 $2,015,586 $(49,845,445) $2,223,835 $ 49,834,537
---------- ----------- ---------- ------------ ---------- ------------
Comprehensive income:
Net income for period 5,762,518 5,762,518
Net unrealized gain on United
States government securities
available for sale (net of
realized gains of $500,206) 410,675 410,675
------------
Total comprehensive income 6,173,193
Issuance of common stock to
consultant 22,222 50,000 50,000
---------- ----------- ---------- ------------ ---------- ------------
BALANCE, DECEMBER 31, 2002 13,887,612 $95,490,561 $2,015,586 $(44,082,927) $2,634,510 $ 56,057,730
========== =========== ========== ============ ========== ============


See the accompanying Notes to the Consolidated Financial Statements.


F-4


DUSA PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS



YEAR ENDED DECEMBER 31,
---------------------------------------------
2002 2001 2000
------------ ------------ ------------

CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net income (loss) $ 5,762,518 $ (7,358,096) $ (6,540,755)
Adjustments to reconcile net income (loss) to net cash used in operating
activities
Amortization of premiums and accretion of discounts on United States
government securities available for sale and investment securities, net (378,089) 738,699 (318,647)
Depreciation and amortization expense 3,247,129 1,066,915 410,473
Amortization of deferred revenue (22,312,498) (1,983,336) (495,833)
Stock based compensation -- 155,067 521,665
Issue of shares of common stock to consultant 50,000 54,750 64,533
Changes in other assets and liabilities impacting cash flows from operations:
Accrued interest receivable 223,795 66,624 (723,463)
Accounts receivable 84,560 793,679 (914,959)
Receivable under co-development program 864,534 (141,964) (722,570)
Inventory 1,144,421 (1,001,114) (1,331,966)
Prepaids and other current assets (424,779) (190,608) (429,407)
Deferred charges (100,000) (400,000) --
Accounts payable 238,002 214,389 (16,609)
Accrued payroll and other accrued expenses 84,477 585,224 1,128,910
Income taxes payable -- -- (90,000)
Deferred revenue (268,258) (235,849) 15,509,207
------------ ------------ ------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (11,784,188) (7,635,620) 6,050,579
------------ ------------ ------------

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Purchases of United States government securities (6,131,356) (23,282,378) (50,506,441)
Proceeds from maturing and sales of United States government securities 18,246,298 24,502,758 13,900,000
Purchases of property, plant and equipment (2,622,158) (2,833,653) (1,553,350)
Deposits on equipment -- 98,000 (70,369)
Payment to restructure supplier contract -- -- (250,000)
Payments to licensor -- (350,000) (350,936)
------------ ------------ ------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 9,492,784 (1,865,273) (38,831,096)
------------ ------------ ------------


See the accompanying Notes to the Consolidated Financial Statements.


F-5


DUSA PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)



YEAR ENDED DECEMBER 31,
----------------------------------------------
2002 2001 2000
----------- ------------ -----------

CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Issuance of common stock and underwriters' options, net of offering
costs of $2,051,714 for 2000 -- -- 40,698,286
Proceeds from long-term debt 1,900,000 -- --
Payments of long-term debt (112,500) -- --
Proceeds from exercise of options and warrants -- 628,279 1,494,727
----------- ------------ -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,787,500 628,279 42,193,013
----------- ------------ -----------
NET INCREASE (DECREASE) IN CASH (503,904) (8,872,614) 9,412,496
CASH AT BEGINNING OF PERIOD 7,568,500 16,441,114 7,028,618
----------- ------------ -----------
CASH AT END OF PERIOD 7,064,596 $ 7,568,500 $16,441,114
=========== ============ ===========

Cash paid for interest $ 41,066 -- --
=========== ============ ===========
Income tax payments -- -- $ 90,000
=========== ============ ===========


During 2000, in connection with the amendment of a supply agreement, the Company
issued 26,667 unregistered shares of DUSA's Common Stock, at a fair market value
of $750,000, to Sochinaz SA.

See the accompanying Notes to the Consolidated Financial Statements.


F-6


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

1) NATURE OF BUSINESS

DUSA Pharmaceuticals, Inc. (the "Company" or "DUSA") was established to
develop prescription pharmaceutical products for all markets, primarily in
the field of photodynamic therapy ("PDT") and photodetection ("PD"), which
combines the use of a pharmaceutical product with exposure to light to
induce a therapeutic or detection effect. The Company has concentrated its
initial efforts on topical and/or local uses of aminolevulinic acid HCl
("Levulan(R)") PDT/PD. On September 28, 2000, the Company launched its
first commercial products, Levulan(R) Kerastick(R) 20% Topical Solution
and the BLU-U(R) brand light source for the treatment of actinic keratoses
(AKs) of the face or scalp.

2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

a) PRINCIPLES OF CONSOLIDATION - The Company's consolidated financial
statements include the accounts of the Company and its wholly-owned
subsidiary, DUSA Pharmaceuticals New York, Inc., which was formed on March
3, 1994 to be the research and development center for the Company. All
intercompany balances and transactions have been eliminated.

b) BASIS OF PRESENTATION AND USE OF ESTIMATES - These financial statements
have been prepared in conformity with accounting principles generally
accepted in the United States of America. Such principles require
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.

c) RECLASSIFICATIONS - Certain prior year amounts have been reclassified
to conform to the current year presentation. Such reclassifications had no
impact on the net income (loss) or shareholders' equity for any period
presented.

d) CASH AND CASH EQUIVALENTS - Cash equivalents include short-term highly
liquid investments purchased with original maturities of 90 days or less.
In December 2001, the Company executed a short-term, renewable,
irrevocable and unconditional letter of credit for $136,018 in lieu of a
security deposit for the construction of the Company's Kerastick(R)
manufacturing facility at its Wilmington, Massachusetts location. The cash
is held in a separate bank account and is recorded in cash and cash
equivalents in the Consolidated Balance Sheets. This line of credit was
renewed in December 2002 and has a balance of $137,883 at December 31,
2002.

e) UNITED STATES GOVERNMENT SECURITIES - The Company follows the
provisions of Statement of Financial Accounting Standards ("SFAS") No.
115, "Accounting for Certain Investments in Debt and Equity Securities."
This Statement requires the Company to record


F-7


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

securities which management has classified as available for sale at fair
market value and to record unrealized gains and losses on securities
available for sale as a separate component of shareholders' equity until
realized.

As the Company's United States government securities are available for
sale, and as management expects to sell a portion of its United States
government securities in the next fiscal year in order to meet its working
capital requirements, it has classified all securities as current assets.
The premiums and discounts recorded on the purchase of the securities are
amortized into interest income over the life of the securities using the
level-yield method.

f) INVENTORY - Inventory is stated at the lower of cost (first-in,
first-out method) or market. Inventory consisting of BLU-U(R) commercial
light sources is reclassified to property, plant and equipment when the
BLU-U(R) is shipped to physicians under rental, leasing, or demonstration
programs. Inventory identified for research and development activities is
expensed in the period in which that inventory is designated for such use.
In September 2002, based on the termination of the Company's former
dermatology collaboration arrangement, the Company recorded lower of cost
or market adjustments of $2,095,000 for excess inventory and commercial
light units under lease, rental, or trial arrangements to cost of product
sales in its Consolidated Statements of Operations for the year ended
December 31, 2002. (See "Note 3 to the Notes to the Consolidated Financial
Statements - Termination of Dermatology Collaboration Agreement.")

g) PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment are
carried at cost less accumulated depreciation. Depreciation is computed on
a straight-line basis over the estimated lives of the related assets.
Leasehold improvements are amortized over the lesser of their useful lives
or the lease terms.

h) DEFERRED CHARGES AND ROYALTIES - Deferred charges and royalties which
include costs paid in advance to third parties under various agreements
are amortized over their expected terms. (See "Note 3 to the Notes to the
Consolidated Financial Statements - Termination of Dermatology
Collaboration Agreement.")

i) IMPAIRMENT OF LONG-LIVED ASSETS - The Company reviews its long-lived
assets for impairment whenever events or changes in circumstances indicate
that the carrying amount of a long-lived asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison
of the carrying amount of an asset to future net cash flows expected to be
generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets. When
it is determined that the carrying value of long-lived or intangibles
assets may not be recoverable based upon the existence of one or more of
the above indicators of impairment, the asset is written down to its
estimated fair


F-8


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

value on a discounted cash flow basis. In September 2002, the Company
concluded that the termination of the Company's former dermatology
collaboration arrangement did not have any impairment on its manufacturing
facility under construction, but did result in impairment adjustments to
certain intangible assets. (See "Note 3 to the Notes to the Consolidated
Financial Statements - Termination of Dermatology Collaboration
Agreement.")

j) REVENUE RECOGNITION - Revenues on product sales of the Kerastick(R) are
recognized when persuasive evidence of an arrangement exists, the price is
fixed and final, delivery has occurred, and there is reasonable assurance
of collection. Research revenue earned under collaborative agreements
consists of non-refundable research and development funding from a
corporate partner. Research revenue generally compensates the Company for
a portion of agreed-upon research and development expenses and is
recognized as revenue at the time the research and development activities
are performed under the terms of the related agreements and when no future
performance obligations exist. Milestone or other up-front payments have
been recorded as deferred revenue upon receipt and are recognized as
income on a straight-line basis over the term of the Company's agreement
with our collaborator. Based on the termination of the Company's former
dermatology collaboration arrangement, the Company recorded $20,990,000 of
research grant and milestone revenue, in addition to normal amortization
recorded prior to the termination, in its Consolidated Statements of
Operations during the year ended December 31, 2002. (See "Note 3 to the
Notes to the Consolidated Financial Statements - Termination of
Dermatology Collaboration Agreement.")

k) RESEARCH AND DEVELOPMENT COSTS - Costs related to the conceptual
formulation and design of products and processes are expensed as research
and development costs as they are incurred. Purchased technology,
including the costs of licensed technology for a particular research
project and that do not have alternative future uses, are expensed at the
time the costs are incurred.

l) INCOME TAXES - The Company follows the provisions of SFAS No. 109,
"Accounting for Income Taxes," which requires the Company to compute
deferred income taxes based on the difference between the financial
statement and tax basis of assets and liabilities using tax rates expected
to be in effect in the years in which these differences are expected to
reverse.

m) BASIC AND DILUTED NET INCOME (LOSS) PER SHARE - The Company follows the
provisions of SFAS No. 128, "Earnings Per Share." Basic net income (loss)
per common share is based on the weighted average number of shares
outstanding during each period. Stock options and warrants are not
included in the computation of the weighted average number of shares
outstanding for dilutive net income (loss) per common share during each of
the periods presented in the Statement of Operations, as the effect would
be antidilutive. For the years ended December 31, 2002, 2001, and 2000,
stock options and warrants totaling


F-9

DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

approximately 2,553,000, 2,548,000, and 2,340,000 shares, respectively,
have been excluded from the computation of diluted net income (loss) per
share.

n) STOCK-BASED COMPENSATION - SFAS No. 123, "Accounting for Stock-Based
Compensation," addresses the financial accounting and reporting standards
for stock or other equity-based compensation arrangements. The Company has
elected to continue to use the intrinsic value-based method to account for
employee stock option awards under the provisions of Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees," and to
provide disclosures based on the fair value method in the Notes to the
Consolidated Financial Statements as permitted by SFAS No. 123. Stock or
other equity-based compensation for non-employees must be accounted for
under the fair value-based method as required by SFAS No. 123 and Emerging
Issues Task Force ("EITF") No. 96-18, "Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction
with Selling, Goods or Services" and other related interpretations. Under
this method, the equity-based instrument is valued at either the fair
value of the consideration received or the equity instrument issued on the
date of grant. The resulting compensation cost is recognized and charged
to operations over the service period, which is generally the vesting
period.

As described above, the Company uses the intrinsic value method to measure
compensation expense associated with grants of stock options to employees.
Had the Company used the fair value method to measure compensation, the
net income (loss) and net income (loss) per share would have been reported
as follows:



2002 2001 2000
----------- ------------ ------------

NET INCOME (LOSS)

As reported $ 5,762,518 ($7,358,096) ($6,540,755)
Effect on net income (loss) if fair
value method had been used (3,880,231) (5,635,208) (5,606,977)
----------- ------------ ------------
Proforma $ 1,882,287 ($12,993,304) ($12,147,732)
=========== ============ ============

BASIC AND DILUTED NET INCOME (LOSS) PER
COMMON SHARE

As reported $ 0.42 ($0.53) ($0.49)
Effect on net income (loss) per
common share if fair value method
had been used (0.28) (0.41) (0.42)
----------- ------------ ------------
Proforma $ 0.14 ($0.94) ($0.91)
=========== ============ ============



F-10


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

The fair value of the options at the date of grant was estimated using the
Black-Scholes model with the following weighted average assumptions:



2002 2001 2000
----- ----- -----

Expected life (years) 7 7 10

Risk free interest rate 4.89% 4.88% 5.76%

Expected volatility 72.84% 70.87% 74.55%

Dividend yield -- -- --


Using these assumptions, the weighted-average fair value per option for
the years ended December 31, 2002, 2001, and 2000, was $2.53, 10.29 and
$23.07, respectively.

o) COMPREHENSIVE INCOME - The Company has reported comprehensive income
(loss) and its components as part of its Consolidated Statement of
Shareholders' Equity. The only element of comprehensive income, apart from
net income (loss), relates to unrealized gains or losses on United States
government securities.

p) SEGMENT REPORTING - The Company presently operates in one segment,
which is the development and commercialization of emerging technologies
that use drugs in combination with light to treat and detect disease.

q) FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying value of the
Company's financial assets and liabilities approximate their fair values
due to their short-term nature. Marketable securities are carried at fair
market value. The fair market value of the Company's long-term debt is
estimated based on quoted market prices of similar issues having a similar
remaining maturity. The carrying value of the Company's long-term debt
approximates its market value.

r) CONCENTRATION OF CREDIT RISK - The Company invests cash in accordance
with a policy objective that seeks to preserve both liquidity and safety
of principal. The Company is subject to credit risk through short-term
investments and mitigates this risk by investing in United States
government securities.

s) RECENTLY ISSUED ACCOUNTING GUIDANCE - In August 2001, the Financial
Accounting Standards Board issued SFAS No. 144, "Accounting for the
Impairment of Disposal of Long-lived Assets." This statement supercedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." SFAS 144 establishes a single
accounting model, based on the framework established in SFAS 121, for
long-lived assets to be disposed of by sale and resolves implementation
issues related to SFAS 121. SFAS No. 144 is effective for fiscal years
beginning after December 15, 2001 and interim


F-11


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

periods within those fiscal years. On January 1, 2002, the Company adopted
this statement, which had no effect on the Company's financial position or
results of operations upon adoption.

In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an amendment of
FASB SFAS No. 123, "Accounting for Stock-Based Compensation" to provide
alternative methods of transition for a voluntary change to the fair value
based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123
to require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee
compensation and the effect on the method used on reported results. The
Company has determined that it will continue to account for stock-based
compensation to employees under the provisions of APB Opinion No. 25 and
will make all required disclosures in its financial reports to comply with
SFAS 148.

In December 2002, the EITF reached conclusion on EITF Issue No. 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." This
consensus provides guidance in determining when a revenue arrangement with
multiple deliverables should be divided into separate units of accounting,
and, if separation is appropriate, how the arrangement consideration
should be allocated to the identified accounting units. The provisions of
EITF No. 00-21 are effective for revenue arrangements entered into in
fiscal periods beginning after June 15, 2003. The Company will evaluate
multiple element arrangements in accordance with this EITF upon its
effective date for new arrangements into which it enters.

3) TERMINATION OF DERMATOLOGY COLLABORATION AGREEMENT

On September 1, 2002, DUSA and Schering AG, the Company's former marketing
and development partner for Levulan(R) PDT in the field of dermatology,
terminated the parties' marketing, development and supply agreement, dated
November 22, 1999. As a result of this termination, DUSA reacquired all
rights it granted to Schering AG under the agreement. In addition,
Schering AG agreed to continue its financial support for the dermatology
research and development program for the remainder of 2002, including cash
payments totaling $2,050,000, which were received prior to December 31,
2002.

Because of this termination, DUSA evaluated certain items in its
Consolidated Balance Sheet for the timing of revenue recognition and
potential impairment as a result of the termination of the Company's
former dermatology collaboration arrangement. These items included (i) the
unamortized deferred revenue related to non-refundable milestone payments
previously received under the Schering AG agreement and (ii) approximately
$6,950,000 in assets including the Company's nearly completed
manufacturing facility, raw material and finished goods inventories,
commercial light units in the field, and deferred charges and royalties.
As a result of this


F-12


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

analysis, in addition to normal amortization recorded prior to the
termination, the Company recorded the following items in its financial
statements for the year ended December 31, 2002:



REVENUE
RECOGNITION/
ASSET FOOTNOTE
STATEMENT OF OPERATIONS ITEM BALANCE SHEET ITEM IMPAIRMENT REFERENCE
---------------------------- ------------------ ------------ ---------

Revenues:

Research grant and milestone revenue Deferred revenue $20,990,274 Note 10
-----------

Operating Costs:

Cost of product sales Deferred charges $ 542,766 Note 7

Inventory 1,705,364 Note 5

BLU-U(R) units under lease
or rental 389,647 Note 6

Research and development costs Deferred royalty 639,051 Note 7
-----------
Total Charges to Operating Costs $ 3,276,828
-----------


After considering the effects of the change in business circumstances
caused by the termination of the Company's former dermatology
collaboration arrangement, the Company also concluded that the carrying
value of its nearly completed manufacturing facility is more likely than
not fully recoverable. Therefore, no impairment charges were recorded in
2002; however, the Company will continue to periodically review the
carrying value of the facility.

All amounts under the co-development reimbursement have been received as
of December 31, 2002, and based on the termination of the Company's former
dermatology collaboration arrangement there will be no co-development
reimbursement subsequent to 2002.

In December 1999, under the terms of the marketing, development and supply
agreement, DUSA received $15,000,000, reflecting an $8,750,000 cash
milestone payment and $6,250,000 for which a Schering AG affiliate
purchased 340,458 shares of DUSA's common stock. In December 2000, the
Company received an additional $15,000,000 from Schering AG that reflected
an unrestricted research grant of $8,000,000 for future research and
development support to be used at DUSA's discretion, and a milestone
payment of $7,000,000 based on receiving FDA approval of the commercial
model of the BLU-U(R) and the first commercial sale of a Levulan(R)
Kerastick(R). The Company also received royalties


F-13


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

and supply fees from Schering AG based upon the sales levels of the
Kerastick(R). Effective September 1, 2002, such royalty and supply fees
have ceased based on the termination of the Company's former dermatology
collaboration arrangement.

The milestone payments of $15,750,000, the $8,000,000 for future research
and development support, and the premium on the issuance of shares,
$1,041,667, were initially recorded as deferred revenue and were being
recognized over the term of the agreement, approximately 12 years.
However, the unamortized deferred revenue of $20,990,000 as of September
1, 2002 was recognized in revenue based on the termination of the
Company's former dermatology collaboration arrangement as noted in the
above table.

The marketing, development and supply agreement would have terminated on a
product-by-product basis in each country in the territory on the later of
(i) 12 1/2 years after the first commercial sale of a respective product
in such country or (ii) the expiration of patents pertaining to the
manufacture, sale or use of such product in such country.

On September 26, 2001, DUSA and Schering AG amended the now terminated
marketing, development and supply agreement. With the execution of this
amendment, Schering AG and its United States affiliate, Berlex
Laboratories, Inc., agreed to reimburse DUSA $1,000,000 for costs DUSA
incurred to modify its manufacturing agreement with North Safety Products,
Inc. ("North"), the manufacturer of the Company's Kerastick(R) brand
applicator. This amount was reported in deferred liabilities and
recognized in 2002 as an offset to cost of product sales on a
straight-line basis over the term of the amendment.

4) UNITED STATES GOVERNMENT SECURITIES

Securities available for sale consist of United States Treasury Bills,
Notes, and other United States government securities with yields ranging
from 3.95% to 7.21% and maturity dates ranging from January 21, 2003 to
February 15, 2007. The fair market value and cost basis on such securities
were as follows as of December 31, 2002 and 2001:



2002 2001
----------- -----------

Fair market value $45,814,947 $57,141,125

Cost basis 43,180,437 54,917,290


Net unrealized gains on such securities for the years ended December 31,
2002 and 2001 were $410,675 and $1,044,741, respectively, and have been
recorded in accumulated other comprehensive income, which is reported as
part of shareholders' equity in the Consolidated Balance Sheets.


F-14


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

5) INVENTORY

Inventory consisted of the following at December 31, 2002 and 2001:



2002 2001
---------- ----------

Finished goods $1,047,941 $2,013,799

Raw materials 140,718 319,281
---------- ----------

$1,188,659 $2,333,080
========== ==========


DUSA had built up significant inventory levels to support sales effort by
Schering AG. However, in September 2002, the Company recorded lower of
cost or market adjustments for excess BLU-U(R) inventory of $1,594,000,
and $111,000 for bulk Levulan(R) based on (i) the termination of the
Company's former dermatology collaboration arrangement, (ii) limited
product sales since the September 2000 product launch, and (iii) the
Company's expectation of no significant near-term increases in
Kerastick(R) sales levels and/or BLU-U(R) placements. The inventory
charges were recorded in cost of product sales and royalties in the
Company's Consolidated Statements of Operations for the year ended
December 31, 2002. (See "Note 3 to the Notes to the Consolidated Financial
Statements - Termination of Dermatology Collaboration Agreement.")

6) PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consisted of the following at December 31,
2002 and 2001:



USEFUL LIVES
(YEARS) 2002 2001
------------ ----------- ----------

Computer equipment and software 3 $ 1,856,540 $ 1,703,482

BLU-U(R) units in physicians' offices 3 945,436 832,964

Furniture, fixtures and equipment 5 523,831 517,465

Manufacturing equipment 5 1,447,087 1,334,769

Leasehold improvements Term of lease 666,344 627,109

Construction work-in-progress -- 2,596,492 397,783
----------- -----------
8,035,730 5,413,572

Accumulated depreciation and amortization (2,806,047) (1,265,261)
----------- -----------
$ 5,229,683 $ 4,148,311
=========== ===========


Depreciation expense totaled $1,540,786, $715,734, and $281,516 for 2002,
2001, and 2000, respectively.


F-15


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

In September 2002, the Company shortened the useful life of its BLU-U(R)
units under lease, rental, or trial arrangements to reflect a three-year
asset life, and recorded an additional $390,000 of depreciation expense.
This accelerated depreciation policy is attributed to the low level of
BLU-U(R) placements to date, the termination of the Company's former
dermatology collaboration arrangement, including the decision not to
launch the BLU-U(R) in non-US markets (except possibly Canada and/or
Brazil) at this time, and management's expectations that near-term
placements will be limited. The additional depreciation expense was
recorded in cost of product sales and royalties in the Company's
Consolidated Statements of Operations for the year ended December 31,
2002. (See "Note 3 to the Notes to the Consolidated Financial Statements -
Termination of Dermatology Collaboration Agreement.")

Construction work-in-process includes our Kerastick(R) Manufacturing Line
that is currently planned to be put in service in late 2003 or early 2004
with a useful live of approximately 15 years.

7) DEFERRED CHARGES AND ROYALTIES

In September 2002, based on the termination of the Company's former
dermatology collaboration arrangement, the Company charged (i) $509,000 to
cost of product sales and royalties for deferred charges associated with
its amended Supply Agreement with Sochinaz SA, the manufacturer of the
bulk drug ingredient used in Levulan(R), (ii) $33,000 to cost of product
sales and royalties for deferred charges associated with underutilization
costs paid to National Biological Corporation ("NBC"), the manufacturer of
our BLU-U(R), and (iii) $639,000 to research and development costs for
deferred royalties associated with payments to PARTEQ, the Company's
licensor. These amounts represented the unamortized balances of previously
deferred costs which were being amortized over periods ranging from 1 to
12 1/2 years.


F-16


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

Deferred charges and deferred royalties, which include costs paid in
advance to third parties under various agreements were being amortized on
a straight-line basis over the initial expected terms, were as follows as
of December 31, 2001 (there were no outstanding deferred charges as of
December 31, 2002):



2001
----------

Deferred Charges
Facilities underutilization costs $ 933,333
Facilities reimbursement costs 660,375

Deferred Royalty 679,299
----------
Total Deferred Charges and Royalty $2,273,007
==========


8) OTHER ACCRUED EXPENSES

Other accrued expenses consisted of the following at December 31, 2002 and
2001:



2002 2001
---------- ----------

Accrued research and development costs $ 473,543 $ 795,347
Accrued product related costs 463,340 689,857
Accrued license milestone 500,000 --
Accrued legal and other professional fees 297,966 146,199
Accrued employee benefits 207,833 55,576
Other accrued expenses 127,468 94,106
---------- ----------
$2,070,150 $1,781,085
========== ==========


9) LONG-TERM DEBT

Long-term debt consisted of the following as of December 31, 2002 (there
was no long-term debt as of December 31, 2001):



2002
----------

Secured term loan promissory note $1,787,500
Less: Current maturities (270,000)
----------
$1,517,500
==========




F-17


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

In May 2002, DUSA entered into a secured term loan promissory note
("Note") with Citizens Bank of Massachusetts to fund the construction of
its manufacturing facility and borrowed $1,900,000 of a $2,700,000
commitment. The remaining unused amount of the commitment lapsed on June
30, 2002. DUSA made only interest payments at the prime rate through July
1, 2002, and on August 1, 2002 commenced monthly loan repayments with
fixed monthly principal amounts of $22,500 plus interest, which are
scheduled to continue through June 30, 2009. Based on the terms of the
Note, the Company had an option to select a fixed rate or a rate at the
LIBOR interest rate plus 1.75%, for varying LIBOR periods. The Company
selected a 360-day LIBOR-based rate that resulted in a 4% interest rate
for the initial year of the Note. Prior to expiration of the 360-day
LIBOR-based rate for each year of the loan, DUSA can either continue to
choose a LIBOR-based rate at that time, execute a one-time conversion to a
fixed rate loan, or repay the loan balance. The Company capitalized
approximately $47,000 of interest in 2002 related to the Note.
Approximately $3,000,000 of the Company's United States government
securities are pledged as collateral to secure the loan. Principal
payments due in each of the next five years amount to $270,000 per year.

10) DEFERRED REVENUE

In September 2002, based on the termination of the Company's former
dermatology collaboration arrangement, the Company accelerated the
recognition of $20,990,000 of previously unamortized research grant and
milestone revenue, in addition to normal amortization recorded prior to
the termination, in the Company Consolidated Statements of Operations for
the year ended December 31, 2002. (See "Note 3 to the Notes to the
Consolidated Financial Statements - Termination of Dermatology
Collaboration Agreement.")

Deferred revenue, both short and long-term, consisted of the following at
December 31, 2002 and 2001:



DECEMBER 31, DECEMBER 31,
2002 2001
------------ ------------

Milestone and unrestricted grant payments $ -- $22,312,498
Lease or rental of BLU-U(R) units -- 273,358
Sale of Levulan(R) Kerastick(R) units 5,100 --
----------- -----------
$ 5,100 $22,585,856
=========== ===========


Effective September 1, 2002, DUSA engaged a third-party distributor to be
its exclusive distributor of the Levulan(R) Kerastick(R) in the United
States. The Company has recorded


F-18


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

$5,100 of deferred revenue for Kerastick(R) units sold to the distributor
as the price was not fixed and final, since the distributor has a right of
return on Kerastick(R) units. (See "Note 15 to the Notes to the
Consolidated Financial Statements - Third-Party Distribution Agreement".)

During the first half of 2002, deferred revenue of $273,000 related to the
sale of BLU-U(R) units was reclassified to other accrued expenses, then
repaid to a third party.

11) INCOME TAXES

The tax effect of significant temporary differences representing deferred
tax assets and liabilities at December 31, 2002 and 2001 is as follows:



2002 2001
------------ ------------

DEFERRED TAX ASSETS
Deferred revenue $ 2,000 $ 9,484,000
Intangible assets 588,000 652,000
Accrued charges 46,000 17,000
Research and development tax credits carryforwards 2,144,000 1,394,000
Operating loss carryforwards 18,253,000 10,854,000
Capital loss carryforwards 1,000 1,000
Charitable contribution carryforward 4,000 4,000
Deferred Charges 405,000 --
License fee 202,000 --
Reserves 823,000 --
------------ ------------
Total deferred tax assets 22,468,000 22,406,000

DEFERRED TAX LIABILITIES
Deferred charges -- (79,000)

Fixed assets (8,000) (58,000)
------------ ------------
Total deferred tax liabilities $ (8,000) $ (137,000)
------------ ------------
Net deferred tax assets before allowance 22,460,000 22,269,000

Valuation allowance (22,460,000) (22,269,000)
------------ ------------
Total deferred tax asset $ -- $ --
============ ============


During the years ended December 31, 2002, 2001, and 2000, the valuation
allowance was increased by approximately $191,000, $4,372,000, and
$2,631,000, respectively, due to the uncertainty of future realization of
the net deferred tax assets.


F-19


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

Included in deferred tax assets at December 31, 2002 and 2001 is
$1,600,000 in both years of future benefits which, if realized, will be
credited to additional paid in capital rather than results of operations.

As of December 31, 2002, the Company has Federal net operating loss
carryforwards for tax purposes of approximately $45,125,000 and research
and development tax credits of approximately $1,605,000, both of which, if
not utilized, will expire for Federal tax purposes as follows:



RESEARCH AND
OPERATING LOSS DEVELOPMENT TAX
CARRYFORWARDS CREDITS
-------------- ---------------


2006 $ -- $ 7,000
2007 -- 57,000
2008 -- 66,000
2009 -- 84,000
2010 -- 44,000
2011 2,325,000 102,000
2012 6,638,000 235,000
2013 6,841,000 --
2018 5,738,000 145,000
2019 1,000 81,000
2020 28,000 159,000
2021 8,934,000 284,000
2022 14,620,000 341,000
---------- ---------
$45,125,000 $1,605,000
========== =========


A reconciliation between the effective tax rate and the statutory Federal
rate is as follows:



2002 2001 2000
------------------- -------------------- ---------------------
$ % $ % $ %
------------------- -------------------- ---------------------

Income tax expense (benefit) at statutory rates 1,959,000 34.0 (2,502,000) (34.0) (2,205,000) (34.0)

State taxes 371,000 6.4 (500,000) (6.8) (425,000) (6.5)

(Increase) decrease in tax credit carryforwards (603,000) (10.5) (335,000) (4.6) 38,000 0.5

Change in valuation allowance including (1,737,000) (30.1) 3,265,000 44.4 2,631,000 40.6
revisions of prior year estimates

Other 10,000 0.2 72,000 1.0 (39,000) (0.6)
------------------- -------------------- ---------------------
-- -- -- -- -- --
=================== ==================== =====================



F-20


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

12) SHAREHOLDERS' EQUITY

On March 22, 2000, the Company issued 1,500,000 shares of its common stock
in a private placement pursuant to Regulation D of the Securities Act of
1933. The Company received gross proceeds of $42,750,000. The offering
costs associated with the placement were $2,051,714. The shares were
registered on a Form S-3 Registration Statement which became effective on
March 22, 2000.

In June 2000, the Company amended its Supply Agreement with Sochinaz SA,
the manufacturer of the bulk drug ingredient used in Levulan(R). As
partial consideration for the amendment, DUSA issued 26,667 unregistered
shares of DUSA's Common Stock, at a fair market value of $750,000.

On September 18, 2000, the Company granted 2,500 shares of unregistered
common stock, without par value, to an outside consultant for compensation
of services. These shares were valued at approximately $65,000 and were
recorded as part of general and administrative costs in the Consolidated
Statements of Operations.

On October 4, 2001, the Company granted 5,000 shares of unregistered
common stock, without par value, to Therapeutics, Inc., a clinical
research organization, engaged to manage the clinical development of the
Company's products in the field of dermatology. These shares were valued
at approximately $55,000, and were recorded in research and development
expense in the Consolidated Statement of Operations.

On June 15, 2002, the Company granted 22,222 shares of unregistered common
stock, without par value, pursuant to an agreement for services to
Therapeutics, Inc. These shares were valued at $50,000 in 2002, and were
recorded in research and development expense in the Consolidated Statement
of Operations.

On September 27, 2002, the Company adopted a shareholder rights plan (the
"Rights Plan") at a special meeting of the Board of Directors. The Rights
Plan provides for the distribution of one right as a dividend for each
outstanding share of common stock of the Company to holders of record as
of October 10, 2002. Each right entitles the registered holder to purchase
one one-thousandths of a share of preferred stock at an exercise price of
$37.00 per right. The rights will be exercisable subsequent to the date
that a person or group either has acquired, obtained the right to acquire,
or commences or discloses an intention to commence a tender offer to
acquire, 15% or more of the Company's outstanding common stock (or 20% of
the outstanding common stock in the case of a shareholder or group who
beneficially held in excess of 15% at the record date), or if a person or
group is declared an Adverse Person, as such term is defined in the Rights
Plan. The rights may be redeemed by the Company at a redemption price of
one one-hundredth of a cent per right until ten days following the date


F-21


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

the person or group acquires, or discloses an intention to acquire, 15% or
20% or more, as the case may be, of the Company, or until such later date
as may be determined by the Board.

Under the Rights Plan, if a person or group acquires the threshold amount
of common stock, all holders of rights (other than the acquiring
shareholder) may, upon payment of the purchase price then in effect,
purchase shares of common stock having a value of twice the purchase
price. In the event that the Company is involved in a merger or other
similar transaction where it is not the surviving corporation, all holders
of rights (other than the acquiring shareholder) shall be entitled, upon
payment of the purchase price then in effect, to purchase common stock of
the surviving corporation having a value of twice the purchase price. The
rights will expire on October 10, 2012, unless previously redeemed. The
Board has adopted certain amendments to the Company's Certificate of
Incorporation consistent with the terms of the Rights Plan.

13) STOCK OPTIONS AND WARRANTS

a) 1996 OMNIBUS PLAN - The 1996 Omnibus Plan ("Omnibus Plan"), as amended,
provides for the granting of awards to purchase up to a maximum of 20% of
the Company's common stock outstanding or a maximum of 2,753,328. The
Omnibus Plan is administered by a committee ("Committee") established by
the Board of Directors. The Omnibus Plan enables the Committee to grant
non-qualified stock options ("NQSO"), incentive stock options ("ISO"),
stock appreciation rights ("SAR"), restricted stock ("RS"), or other
securities determined by the Company, to directors, employees and
consultants. To date, the Company has made awards of NQSOs, ISOs, and RSs
under the Omnibus Plan.

Non-qualified stock options - All the NQSOs granted under the Omnibus Plan
have an expiration period not exceeding ten years and are issued at a
price not less than the market value of the common stock on the grant
date. The Company initially grants each individual who agrees to become a
director 15,000 NQSO to purchase common stock of the Company. These
initial grants vest annually over a four-year period and, thereafter, each
director reelected at an Annual Meeting of Shareholders will automatically
receive an additional 10,000 NQSO on June 30 of each year except for 2001,
for which each director received 5,000 NQSO based on an agreement at the
June 14, 2001 shareholder meeting. These grants immediately vest on the
date of the grant.

Incentive stock options - ISOs granted under the Omnibus Plan have an
expiration period not exceeding ten years (five years for ISOs granted to
employees who are also ten percent shareholders) and are issued at a price
not less than the market value of the common stock on the grant date.
These options become exercisable at a rate of one quarter of the total
granted on each of the first, second, third and fourth anniversaries of
the grant date subject to satisfaction of certain conditions involving
continuous periods of service.


F-22


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

The following table summarizes information about all stock options
outstanding at December 31, 2002:



OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------------------------------------
NUMBER WEIGHTED NUMBER
OUTSTANDING AT WEIGHTED AVERAGE AVERAGE EXERCISABLE WEIGHTED
DECEMBER 31, REMAINING EXERCISE AT DECEMBER AVERAGE
RANGE OF EXERCISE PRICE 2002 CONTRACTUAL LIFE PRICE 31, 2002 EXERCISE PRICE
----------------------- -------------- ---------------- -------- ----------- --------------

$2.90 to 6.38 731,700 6.19 years $ 5.11 501,700 $ 5.34
6.69 to 8.63 463,750 3.34 years 7.67 463,750 7.67
9.25 to 15.64 462,000 6.19 years 11.80 365,626 11.37
15.75 to 27.31 275,125 7.63 years 23.65 168,000 23.75
31.00 to 31.00 320,500 7.18 years 31.00 167,750 31.00
--------- ---------
2,253,075 5.92 years 12.95 1,666,826 11.75
========= =========


Activity under stock option plans during the years ended December 31,
2002, 2001 and 2000 was as follows:



WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
2002 PRICE 2001 PRICE 2000 PRICE
--------- -------- --------- -------- --------- --------

Options outstanding, beginning of year 2,197,450 $14.30 2,140,450 $13.54 1,757,800 $ 7.58

Options granted 275,000 3.65 215,500 14.53 641,500 28.44

Options exercised -- -- (104,500) 5.95 (188,350) 5.57

Options cancelled (219,375) 14.67 (54,000) 7.66 (70,500) 16.38
--------- ------ --------- ------ --------- ------
Options outstanding, end of year 2,253,075 $12.95 2,197,450 $14.30 2,140,450 $13.54
--------- ------ --------- ------ --------- ------
Options exercisable, end of year 1,666,826 $11.75 1,364,700 $10.97 1,195,013 $ 8.36
========= ====== ========= ====== ========= ======


Options that were granted during 2002, 2001 and 2000 have exercise prices
ranging from $2.90 to $4.01 per share, $8.05 to $17.63 per share, and
$16.88 to $31.00 per share, respectively.

There were no option exercises in 2002. Options which were exercised
during 2001 and 2000 were exercised at per share prices ranging from $3.25
to $7.25, and $3.25 to $11.50, respectively.

On August 16, 2000, the Company issued 2,500 fully-vested options to an
outside consultant for compensation of services. These options were valued
at approximately $26,000, and


F-23


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

were recorded as part of general and administrative costs in the
Consolidated Statements of Operations. These options expired in 2001.

On October 21, 1997, the Company issued 85,000 options to PARTEQ. These
options were valued at approximately $155,000 and $496,000 in 2001 and
2000, respectively and recorded as part of research and development costs
in the Consolidated Statements of Operations in accordance with EITF
96-18. As of December 31, 2002, all of these options remained outstanding.

Also as discussed in Note 14(a), on June 23, 1999, the Company issued
10,000 options to PARTEQ. As of December 31, 2002, all of these options
remained outstanding.

b) WARRANTS - On January 17, 2002, the Company extended the term of
300,000 Class B warrants, which were previously issued to the Chief
Executive Officer of the Company, from January 29, 2002 to January 29,
2007. 50,000 of the Class B warrants lapsed. No compensation expense
resulted from the extension of these warrants as the intrinsic value of
these warrants at the date of extension was zero. As of December 31, 2002,
300,000 of the remaining warrants were outstanding. The exercise price of
the warrants is CDN $6.79 (U.S. $4.30 at December 31, 2002).

In connection with an agreement dated October 6, 1993, the Company issued
its investor relations firm a warrant to purchase up to 50,000 shares of
the authorized stock of the Company at $6 per share. During 2001 and 2000,
the investor relations firm exercised 25,000 shares in each year.

In connection with an agreement with its international investor relations
advisor, in 1995 the Company issued warrants for 20,000 shares of the
Company's common stock, exercisable at a price of $4.00 per share. During
2000, all 20,000 warrants were exercised.

In 1999 the Company issued 163,043 warrants as commission to a placement
agent with an exercise price of $5.00 per share. As of December 31, 2002
and 2001, 449 of the warrants were outstanding and expire in 2004.


F-24


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

14) COMMITMENTS AND CONTINGENCIES

a) PARTEQ AGREEMENTS - The Company licenses certain patents underlying its
Levulan(R) PDT/PD systems under a license agreement with PARTEQ Research
and Development Innovations, the licensing arm of Queen's University,
Kingston, Ontario. Under the agreement, the Company has been granted an
exclusive worldwide license, with a right to sublicense, under PARTEQ
patent rights, to make, have made, use and sell certain products,
including ALA. The agreement covers certain use patent rights.

When the Company is selling its products directly, it has agreed to pay to
PARTEQ royalties of 6% and 4% on 66% of the net selling price in countries
where patent rights do and do not exist, respectively. In cases where the
Company has a sublicensee, it will pay 6% and 4% when patent rights do and
do not exist, respectively, on its net selling price less the cost of
goods for products sold to the sublicensee, and 6% of payments the Company
receives on sales of products by the sublicensee.

For the years ended December 31, 2002, 2001 and 2000, actual royalties
based on product sales were approximately $12,200, $3,300, and $5,800,
respectively, however, based on the minimum royalty requirements, the
Company incurred a total liability of $64,000, $63,000 and $68,000 in
2002, 2001, and 2000, respectively, which has been recorded in cost of
product sales and royalties. Commencing with the initial product launch,
annual minimum royalties to PARTEQ must total at least CDN $100,000
(U.S. $64,000 as of December 31, 2002).

The Company is also obligated to pay 5% of any lump sum sublicense fees
paid to the Company, such as milestone payments, excluding amounts
designated by the sublicensee for future research and development efforts.

b) LEASE AGREEMENTS - The Company has entered into lease commitments for
office space in Wilmington, Massachusetts, Valhalla, New York, and
Toronto, Ontario including an extended lease commitment in 2001 for its
office and manufacturing space in its Wilmington headquarters through
November 2016. The Company has the ability to terminate the Wilmington
lease after the 10th year (2011) of the lease by providing the landlord
with notice at least seven and one-half months prior to the date on which
the termination would be effective. Commencing in August 2002, the Company
entered into a new 5 year lease commitment for its Toronto location. In
October 2002, the Company also entered into a 5 year extended lease
commitment at its Valhalla location. The minimum lease payments disclosed
below include the non-cancelable term of the lease. Future minimum lease
payments related to these agreements for years subsequent to December 31,
2002 are as follows:


F-25


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000



MINIMUM LEASE
PAYMENTS
-------------

2003 $ 401,000

2004 417,000

2005 465,000

2006 400,000

2007 410,000

Beyond 2007 2,020,000
----------

$4,113,000
==========


Rent expense incurred under these operating leases was approximately
$458,000, $461,000, and $297,000 for the years ended December 31, 2002,
2001, and 2000, respectively.

c) RESEARCH AGREEMENTS - The Company has entered into a series of
agreements for research projects and clinical studies. As of December 31,
2002, future payments to be made pursuant to these agreements, under
certain terms and conditions, totaled approximately $3,433,000 and
$767,000 for 2003 and 2004, respectively. On October 4, 2001, the Company
executed a master service agreement, effective June 15, 2001, with
Therapeutics, Inc. for an initial term of two years to engage Therapeutics
to manage the clinical development of the Company's products in the field
of dermatology. Minimum payments under this agreement have been included
in the total future payments as noted above. Upon execution of this
agreement, Therapeutics received 5,000 shares of the Company's common
stock valued at $55,000, received an additional grant of 22,222 shares
valued at $50,000. Therapeutics has the opportunity for additional stock
grants, bonuses, and other incentives for each product indication ranging
from $250,000 to $1,250,000 depending on the regulatory phase of
development of products during Therapeutics' management.

d) LEGAL MATTERS - In April 2002, DUSA received a copy of a notice issued
by PhotoCure ASA to Queen's University at Kingston, Ontario, which was
provided to us by PARTEQ, alleging that Australian Patent No. 624985 is
invalid. Australian Patent No. 624985 is one of the patents licensed by
PARTEQ to DUSA, relating to the Company's 5-aminolevulinic acid
technology. As a consequence of this action, Queen's University has
assigned the Australian patent to DUSA so that DUSA may participate
directly in this litigation. DUSA has filed an answer setting forth its
defenses and a related countersuit alleging that PhotoCure's activities
infringe the patent. The case is in its earliest stages so the Company is
unable to predict the outcome at this time.


F-26


DUSA PHARMACEUTICALS, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 2002, 2001, AND 2000

15) LICENSE AND SUPPLY AGREEMENTS

On December 30, 2002, DUSA entered into a License and Development
Agreement with Photonamic GmbH & Co. KG, a subsidiary of medac GmbH, a
German pharmaceutical company, and a supply agreement with medac. These
agreements provide for the licensing to DUSA of Photonamic's proprietary
technology related to ALA for systemic dosing in the field of brain
cancer. Based on the license agreement, DUSA will make a non-refundable
$500,000 milestone payment to Photonamic in 2003. This liability was
charged to research and development costs in the Consolidated Statement of
Operations in 2002, and is included in other accrued expenses in the
Consolidated Balance Sheet at December 31, 2002. The Company may also be
obligated to pay certain regulatory milestones and royalties on net sales
of a brain cancer product under the terms of the License and Development
Agreement, and will purchase product under the supply agreement for
mutually agreed upon indications. Should Photonamic's clinical study be
successful, DUSA will be obligated to proceed with development of the
product in the United States in order to retain the license for the use of
the technology to treat brain cancer. Such additional obligations are
undeterminable at this time.

16) THIRD-PARTY DISTRIBUTION AGREEMENT

Effective September 1, 2002, DUSA engaged Moore Medical Corporation, a
national distributor and marketer of medical and surgical supplies, to be
its exclusive distributor of the Kerastick(R) in the United States. The
agreement has a one-year term, which can be automatically renewed for
additional one-year terms, unless either party notifies the other party
prior to a term expiration that it does not intend to renew the agreement.
In addition, either party may terminate the agreement earlier, on certain
terms, or in the event that the other party shall have materially breached
any of its obligations in the agreement. Moore has a right to return its
inventory of Kerastick(R) units for full credit for a period of time prior
to and after the expiration date of the agreement. Accordingly, DUSA
recognizes product sales when Moore sells the Kerastick(R) to the end-user
as the price is fixed and final to Moore at that point.

17) RELATED PARTY TRANSACTIONS

The Company's Vice President of Technology and former Vice President of
Business Development are principal shareholders of Lumenetics, Inc., the
Company's former light device consultants. During 2000, the Company paid
$2,000 for certain equipment leased under operating leases from
Lumenetics. In 2001, the Company purchased this equipment for $52,000.


F-27


EXHIBIT INDEX

3(a)(i) Certificate of Incorporation, as amended, filed as Exhibit 3(a) to
the Registrant's Form 10-K for the fiscal year ended December 31,
1998, and is incorporated herein by reference;

3(a)(ii) Certificate of Amendment to the Certificate of Incorporation, as
amended, dated October 28, 2002 and filed as Exhibit 99.3 to the
Registrant's Quarterly Report on Form 10-Q for the fiscal quarter
ended September 30, 2002, filed November 12, 2002 and incorporated
herein by reference; and

3(b) By-laws of the Registrant, filed as Exhibit 3(ii) to the
Registrant's Quarterly Report on Form 10-Q for the fiscal quarter
ended September 30, 1997, and are incorporated herein by reference.

4(a) Common Stock specimen;

4(b) Class B Warrant, filed as Exhibit 4.3 to the Registrant's
Registration Statement on Form S-1, No. 33-43282, and is
incorporated herein by reference;

4(c) Rights Agreement filed as Exhibit 4.0 to Registrant's Current Report
on Form 8-K dated September 27, 2002, filed October 11, 2002, and is
incorporated herein by reference; and

4(d) Rights Certificate relating to the rights granted to holders of
common stock under the Rights Agreement filed as Exhibit 4.0 to
Registrant's Current Report on Form 8-K, dated September 27, 2002,
filed October 11, 2002, and is incorporated herein by reference.

10(a) License Agreement between the Company, PARTEQ and Draxis Health Inc.
dated August 27, 1991, filed as Exhibit 10.1 to the Registrant's
Registration Statement on Form S-1, No. 33-43282, and is
incorporated herein by reference;

10(b) ALA Assignment Agreement between the Company, PARTEQ, and Draxis
Health Inc. dated October 7, 1991, filed as Exhibit 10.2 to the
Registrant's Registration Statement on Form S-1, No. 33-43282, and
is incorporated herein by reference;

10(b.1) Amended and Restated Assignment between the Company and Draxis
Health Inc., dated April 16, 1999, filed as Exhibit 10(b.1) to the
Registrant's Form 10-K for the fiscal year ended December 31, 1999,
and is incorporated herein by reference;



10(c) Employment Agreement of D. Geoffrey Shulman, MD, FRCPC dated October
1, 1991, filed as Exhibit 10.4 to the Registrant's Registration
Statement on Form S-1, No. 33-43282, and is incorporated herein by
reference;

10(d) Amendment to Employment Agreement of D. Geoffrey Shulman, MD, FRCPC
dated April 14, 1994, filed as Exhibit 10.4 to the Registrant's
Registration Statement on Form S-2, No. 33-98030, and is
incorporated hereby by reference;

10(e) Amended and Restated License Agreement between the Company and
PARTEQ dated March 11, 1998, filed as Exhibit 10(e) to the
Registrant's Form 10-K/A filed on June 18, 1999, portions of Exhibit
A have been omitted pursuant to a request for confidential treatment
pursuant to Rule 24b-2 of the Securities Exchange Act of 1934 and
Rule 406 of the Securities Act of 1933, and is incorporated herein
by reference;

10(f) Incentive Stock Option Plan, filed as Exhibit 10.11 of Registrant's
Registration Statement on Form S-1, No. 33-43282, and is
incorporated herein by reference;

10(g) 1994 Restricted Stock Option Plan, filed as Exhibit 1 to
Registrant's Schedule 14A definitive Proxy Statement dated April 26,
1995, and is incorporated herein by reference;

10(h) 1996 Omnibus Plan, as amended, filed as Appendix A to Registrant's
Schedule 14A definitive Proxy Statement dated April 26, 2001, and is
incorporated herein by reference;

10(i) Purchase and Supply Agreement between the Company and National
Biological Corporation dated November 5, 1998, filed as Exhibit
10(i) to the Registrant's Form 10-K/A filed on June 18, 1999,
portions of which have been omitted pursuant to a request for
confidential treatment pursuant to Rule 24b-2 of the Securities
Exchange Act of 1934 and Rule 406 of the Securities Act of 1933, and
is incorporated herein by reference;

10(j) Common Stock Purchase Agreement between the Company and Schering
Berlin Venture Corporation dated as of November 22, 1999, filed as
Exhibit 10.2 to the Registrant's Current Report on Form 8-K dated
November 22, 1999, portions of which have been omitted pursuant to a
request for confidential treatment pursuant to Rule 24b-2 of the
Securities Exchange Act of 1934, and is incorporated herein by
reference;

10(k) Purchase and Supply Agreement between the Company and North Safety
Products, Inc. dated as of September 13, 1999, filed as Exhibit 10.1
to the Registrant's Current Report on Form 8-K dated October 13,
1999, portions of which have been omitted pursuant to a request for
confidential treatment



pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, and
is incorporated herein by reference;

10(k.1) Amendment to Purchase and Supply Agreement between the Company and
North Safety Products, Inc. dated as of February 15, 2001, portions
of which have been omitted pursuant to a request for confidential
treatment pursuant to Rule 24b-2 of the Securities Exchange Act of
1934, as amended filed as Exhibit 10(p.1) to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 2001,
filed on March 15, 2002, and is incorporated herein by reference;

10(k.2) Second Amendment to Purchase and Supply Agreement between the
Company and North Safety Products, Inc. dated as of July 26, 2001,
portions of which have been omitted pursuant to a request for
confidential treatment pursuant to Rule 24b-2 of the Securities
Exchange Act of 1934, as amended filed as Exhibit 10(p.2) to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 2001, filed on March 15, 2002, and is incorporated
herein by reference;

10(l) Supply Agreement between the Company and Sochinaz SA dated December
dated December 24, 1993, filed as Exhibit 10(q) to Registrants Form
10-K/Afiled on March 21, 2000, portions of which have been omitted
pursuant to a request for confidential treatment pursuant to Rule
24b-2 of the Securities Exchange Act of 1934, and is incorporated
herein by reference;

10(l.1) First Amendment to Supply Agreement between the Company and Sochinaz
SA dated July 7, 1994 filed as Exhibit 10(q.1) to Registrant's
Annual Report on Form 10-K for the fiscal year ended December 31,
1999, and is incorporated herein by reference;

10(l.2) Second amendment to Supply Agreement between the Company and
Sochinaz SA dated as of June 20, 2000, filed as Exhibit 10.1 to
Registrant's Current Report on Form 8-K dated June 28, 2000, and is
incorporated herein by reference;

10(m) Master Service Agreement between the Company and Therapeutics, Inc.
dated as of October 4, 2001, filed as Exhibit 10(b) to the
Registrant's quarterly report on Form 10-Q for the fiscal quarter
ended September 30, 2001, filed November 8, 2001, portions of which
have been omitted pursuant to a request for confidential treatment
under Rule 24b-2 of the Securities Exchange Act of 1934, as amended
and is incorporated herein by reference;

10(n) Commercial Loan Agreement, Secured Term Loan Promissory Note and
Pledge and Security Agreement between the Company and Citizens Bank
of Massachusetts dated May 13, 2002 filed as Exhibit 99.1 to the
Registrant's Quarterly Report on Form 10-Q for the fiscal quarter
ended March 31, 2002, filed May 14, 2002, and is incorporated herein
by reference;



10(o) Collaboration Termination Agreement, effective September 1, 2002,
between DUSA and Schering AG, the Company's former marketing
partner, filed as Exhibit 10 to Registrant's Current Report on Form
8-K dated August 27, 2002, and is incorporated herein by reference;

10(p) Wholesale Distribution Agreement, effective September 1, 2002,
between DUSA and Moore Medical Corporation, filed as Exhibit 10.1 to
the Registrant's quarterly report on Form 10-Q for the fiscal
quarter ended September 30, 2002, filed November 12, 2002, portions
of which have been omitted pursuant to a request for confidential
treatment pursuant to Rule 24b-2 of the Securities Exchange Act of
1934, and is incorporated herein by reference;

10(q) Program Agreement between the Company and Auric Capital Corp. dated
April 18, 2002, filed as Exhibit 10.1 to the Registrant's Quarterly
Report on Form 10-Q for the fiscal quarter ended March 31, 2002,
filed on May 14, 2002, portions of which have been omitted pursuant
to a request for confidential treatment under Rule 24b-2 of the
Securities Exchange Act of 1934, as amended, and is incorporated
herein by reference;

10(r) License and Development Agreement between DUSA Pharmaceuticals, Inc.
and Photonamic GmbH & Co. KG dated as of December 30, 2002, portions
of which have been omitted pursuant to a request for confidential
treatment under Rule 24(b)-2 of the Securities Exchange Act of 1934,
as amended; and

10(s) Supply Agreement between DUSA Pharmaceuticals, Inc. and medac GmbH
dated as of December 30, 2002, portions of which have been omitted
pursuant to a request for confidential treatment under Rule 24(b)-2
of the Securities Exchange Act of 1934, as amended.

23 Independent Auditors' Consent of Deloitte & Touche LLP.

99(a) Certification of the Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002; and

99(b) Press Release dated March 11, 2003.



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

(Registrant) DUSA Pharmaceuticals, Inc.
--------------------------


By (Signature and Title) /s/ D. Geoffrey Shulman President
--------------------------------------
Date: March 11, 2003
--------------

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.



/s/ D. Geoffrey Shulman Director, Chairman of the Board, March 11, 2003
- ------------------------------- President, Chief Executive --------------
D. Geoffrey Shulman, MD, Officer, (Principal Executive Date
FRCPC Officer), Chief Financial Officer
(Principal Financial and
Accounting Officer)


/s/ Mark C. Carota Vice President, Operations March 11, 2003
- ------------------------------- --------------
Mark C. Carota


/s/ Scott L. Lundahl Vice President, Technology March 11, 2003
- ------------------------------- --------------
Scott L. Lundahl


/s/ Stuart L. Marcus Vice President, Scientific Affairs March 11, 2003
- ------------------------------- --------------
Stuart L. Marcus, MD, PhD


/s/ Paul A. Sowyrda Vice President, Product March 11, 2003
- ------------------------------- Development and Marketing --------------
Paul A. Sowyrda


/s/ John H. Abeles Director March 11, 2003
- ------------------------------- --------------
John H. Abeles


/s/ David Bartash Director March 11, 2003
- ------------------------------- --------------
David Bartash







/s/ Jay M. Haft Director March 11, 2003
- ------------------------------- --------------
Jay M. Haft, Esq.


/s/ Richard C. Lufkin Director March 11, 2003
- ------------------------------- --------------
Richard C. Lufkin





DUSA PHARMACEUTICALS, INC.

CERTIFICATIONS

I, D. Geoffrey Shulman, certify that:

1. I have reviewed this annual report on Form 10-K of DUSA Pharmaceuticals,
Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:

a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;

b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and

c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing
the equivalent function):

a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.




Date: March 11, 2003 /s/ D. Geoffrey Shulman
-------------- ------------------------------
D. Geoffrey Shulman
Director, Chairman of the
Board, President, Chief
Executive Officer (principal
executive officer), Chief
Financial Officer (principal
financial and accounting
officer)